Market Economics | Interest Rate Strategy | Forex Strategy 12 May 2011

Market Mover
Market Outlook 2-3
Fundamentals 4-27 „ Weaker-than-expected economic data have pushed
„ Greece: Restructuring Costs 4-7 yields back to the year’s lows.
„ Europe: On the Level 8-9
„ France: Q1 Deficit is Smaller than it 10-11 „ The setback in risk appetite and the sharp correction in
Looks commodity prices in particular have brought support to
„ UK: Bank Balance 12-14 govvies and to the dollar versus risk/commodity/carry
„ Norway: Hiking Cycle Resumes 15 currencies.
„ US Employment: Stock and Flow 16-17
„ Japan: GDP to Contract in Q1 on 17-19 „ Core eurozone markets have also benefited from
Earthquake concerns about peripherals, reversing the recent
„ Japan: Restarting Idle Nuclear 21-22 underperformance versus Treasuries.
Reactors
„ Australia: Cutting Back 23-24 „ JGBs remain closely correlated to Treasuries and are
„ Surprise Indicator 25-27 also back on key resistance levels which, past experience
Interest Rate Strategy 28-57 suggests, will be difficult to break through.
„ US: Cheat Sheet on FHLB TAPs 28-29
„ US: Rich Cheap Points on the Curve 30-31
„ The BoE should maintain its wait-and-see stance, given
32-34
the recent weakness of some activity data.
„ Rally/Sell-Off – MBS Should
Outperform „ A lot has already been priced in – the US curve does
„ EUR: Between Inflation and Soft Patch 35-36 not see any rate hikes in 2011. Hence we are neutral in the
Risk
„ EUR: Liquidity Needs Fall 37 short run. Further weaker-than-expected data are needed to
„ EMU Debt Monitor: CDS, RV Charts, 38-42 allow a decisive break through current resistance levels.
Trade Ideas, Redemptions
„ EUR Vega: Long-Tail Vol on Medium 43 „ The market is also pricing in extreme scenarios when it
Expiries Rich! comes to the EMU crisis although recent comments from
„ JGBs: Focus on Political 44 officials have mostly been about the dire consequences of
Developments a Greek debt restructuring, making additional support the
„ JGBs: Pay 3y/5y/10y Swap Butterfly 45 most likely outcome.
„ Global Inflation Watch 46-49
„ Inflation: Oil – Deleveraging at the 50-52 „ After its recent rebound, the dollar should pause. A
Margin long period of greater currency volatility is in prospect.
„ US: TIPS Auction Preview, etc. 53-54
„ Technical Analysis 55-56
„ The risk of a deeper near-term correction in commodity
„ Trade Reviews 57
prices leaves the AUD, NOK and CAD vulnerable to a
FX Strategy 58-61
further correction.
„ Japanese Retail Rebuilding Yen 58
Shorts
„ Greek Debt Drama: FX Scenario 59 Market Views
Analysis
Current 1 Week 1 Month
„ EURSEK: Lower, Barring Liquidity 60-61
Stress UST 10y T-note Yield (%) 3.23 ↔ ↑
Forecasts & Calendars 62-79
62-63
2y/10y Spread (bp) 268 ↔ ↔↓
„ 1 Week Economic Calendar
„ Key Data Preview 64-73
EGB 10y Bund Yield (%) 3.11 ↔ ↑
„ 4 Week Calendar 74 2y/10y Spread (bp) 134 ↔ ↓
75-76
„ Treasury & SAS Issuance JGB 10y JGB Yield (%) 1.13 ↔ ↑
„ Central Bank Watch 77
„ Economic & Interest Rate Forecasts 78
2y/10y Spread (bp) 94 ↔ ↑
„ FX Forecasts 79 Forex EUR/USD 1.4243 ↑ ↔
Contacts 80 USD/JPY 80.90 ↔ ↔
IMPORTANT NOTICE. Please refer to important disclosures found at the end of
this report. Some sections of this report have been written by our strategy teams
(shown in blue). Such reports do not purport to be an exhaustive analysis and may
be subject to conflicts of interest resulting from their interaction with sales and
www.GlobalMarkets.bnpparibas.com trading which could affect the objectivity of this report.
 Market Outlook
The reassessment of the US growth outlook, renewed concerns about
Greece and the sharp correction of commodity prices have been among the
main drivers recently. Yields are still testing the year’s lows but have failed to
break through them so far. Although the setback in the main stocks indices
has remained relatively limited, attention has been on commodities over the
Yields are back on the past week. After last week’s sharp fall, the rebound of oil prices did not last.
year’s lows… There were a number of factors behind the latest decline, including the CME
raising maintenance margins on gasoline futures for speculators by 21.4%,
the DOE’s bearish energy inventory report, US senators’ request that CFTC
crack down on excessive speculation in crude oil markets and risk aversion
that drove oil back to last week’s lows.
At the same time, the US debt ceiling is about to be hit and the increased
focus on how and when this situation will be resolved may provide a fresh
source of short-term downward pressure on the dollar. The debate over
whether the completion of the Fed’s QE2 programme will be associated with
reduced support for risk assets is also intensifying.
The risk of a deeper near-term correction in commodity prices, whether on
fears of reduced liquidity, position squeezes linked in part to regulatory
changes in commodity futures markets, or a fall in demand after signs of
softer global growth, will continue to support govvies. However, further
…weaker data needed to weaker-than-expected economic data are probably needed for Treasury
break through them yields to decisively break below this year’s low. The CPI report on 13 May
and the FOMC minutes on 18 May will be among the potential market
movers. We are neutral at current levels and remain bearish medium term,
although, for the aforementioned reasons, the risk of an extended rally has
recently risen.
Commodity prices under the spotlight
1 1 5 1 .5 0

1 1 0
E U R /U S D ( In v . R .H .S ) 1 .4 5
1 0 5

1 0 0 1 .4 0

9 5
1 .3 5
9 0
1 .3 0
8 5

8 0 1 .2 5
7 5 O il ( W T I)
1 .2 0
7 0

6 5 1 .1 5
M a r M a y J u l S e p N o v J a n M a r M a y
1 0 1 1
Source : Reuters EcoWin Pro
In Europe, EGBs will remain partly driven by the vulnerability of peripherals,
which has allowed the recent outperformance against Treasuries in the rally,
pushing the 10y T-note/Bund spread back into positive territory. The
divergence between Fed/BoE and ECB policies remains a key theme in
EMU concerns are adding financial markets. From a risk perspective, the chances of a soft patch
support to core EGBs materialising in the euro area have also increased recently (see “EUR:
Between Inflation and Soft Patch” for investors looking for a hedge against
the soft patch scenario).
The political news flow has been more favourable recently, with progress
being made on providing Greece with additional assistance to plug its
financing gap in 2012, while Finland's parliament finally appears to have
opened the door to the upcoming Ecofin meeting rubber stamping the
programme for Portugal.

Cyril Beuzit 12 May 2011

Market Mover 2 www.GlobalMarkets.bnpparibas.com
 Still, the course of events will remain very changeable and some politicians’
desire to ‘burden share’ remains a source of event risk (see “Greece:
Restructuring Costs”). After the Ecofin meeting, the EU/ECB/IMF troika's
review of Greece's progress at the end of the month remains the focal point.
Key dates for Greece The main topic under discussion seems to be what Greece can give or
promise in order to receive this extra support in 2012 and 2013, and not
whether it is going to get it or not. Greece will need around EUR 60bn to be
fully funded for 2012 and 2013.
The immediate focus data-wise is 'flash' Q1 GDP data for the eurozone,
which will again highlight core/peripheral divergence. But the core countries
account for most of the eurozone’s output (as stressed in a recent speech by
ECB Executive Board Member Jürgen Stark), which points to a robust
growth rate for the eurozone as a whole – and rate hikes continuing in the
absence of peripheral problems turning into a systemic problem. Inflation
data for April will confirm that headline inflation is closer to 3% than 2%, with
a sharp rise in core inflation (which we expect to partly unwind in May).
The ECB's Survey of Professional Forecasters (SPF) published in May’s
Monthly Bulletin showed participants' inflation expectations rising across the
board. The probability distributions associated with the forecasts, a focus of
the ECB's analysis in the past, have also continued to shift upwards. While
the upward revisions were relatively small, the SPF will continue to keep the
ECB alert to the risk of inflation expectations becoming unanchored.
In the UK, the market’s interpretation of the latest BoE Inflation Report was
relatively hawkish, as the near-term inflation projection was revised up
substantially. The projections are indicative of a need for tighter policy – but
so were the previous batch and the BoE did not deliver. Our inclination at
this point is to see the market reaction as overdone. This reflects various
factors, including the apparent willingness of the Bank of England to look
BoE is in a ‘wait and see' through the rise of inflation and to focus on medium-term drivers. The recent
mode weakness of some activity data will reinforce the tendency of the majority of
MPC members to take a 'wait and see' view. If this recent weakness
continues, the probability of a 'no change' scenario would increase markedly,
in our view.
JGBs followed the rally in US Treasuries but market participants appear
reluctant to chase the 10y JGB yield below 1.1%, and the 5y and 20y yields
are also near psychologically important levels at 0.4% and 1.9%,
respectively. We may need fresh buying incentives to break below those
levels significantly, noting that the 5y yield has rarely fallen below 0.4% other
than during the exceptional cases of 2002-03 and 2010.
The newly issued 10y JGB met reasonable demand at the auction with some
tailwinds on the Japanese bond market, such as a global economic
JGBs remain closely slowdown including Japan, the possibility of further monetary policy easing
correlated to Treasuries by the BoJ, political turmoil in Japan leading to talk of delay of a second
supplementary budget and, finally, the resurgence of concern about
peripherals in the euro area.
On the foreign exchange market, price action in recent days in EURUSD in
particular and commodity currencies in general, is hinting that the lengthy
period of unrelenting trend deterioration in the dollar and support for
risk/commodity/carry currencies may have reached at least a temporary
hiatus. An extended period of higher currency volatility is in prospect. While
the broard thrust of contrasting Fed and ECB policy dispositions is likely to
Higher currency volatility remain a major force underpinning EURUSD, uncertainty about the
substance of an additional fiscal support package for Greece remains a
ahead
significant near-term swing factor, albeit one we expect to be resolved in a
euro-supportive fashion. The risk of a deeper near-term correction in
commodity prices leaves the AUD, NOK and CAD vulnerable to a further
correction.

Cyril Beuzit 12 May 2011

Market Mover 3 www.GlobalMarkets.bnpparibas.com
Greece: Restructuring Costs
„ A question we have often been asked
recently is: if a restructuring of Greek debt is
inevitable, why not get it over and done with
now?
„ We have some sympathy with this
argument, but the costs of debt restructuring by
far outweigh its benefits.
„ Debt restructuring would have a significant
fallout on Greece’s banking sector and its
economy.
„ It would also risk having serious
implications for the eurozone banking sector
and spill-over effects on other peripheral
economies.
„ There is therefore value in waiting.
„ The most likely result is more money for
Greece from official sources in 2012 and
probably 2013 as well, with some voluntary
move on extending the maturity of some
privately held debt.
„ We doubt that a definitive solution will be
agreed before the conclusion of the EU/IMF
quarterly review of the Greek programme at the
end of the month.
„ Recent Greek developments have shown
that the EU crisis resolution mechanism still
lacks the political consensus needed for it to
effectively respond to unexpected events.
„ This leaves the eurozone bond market
vulnerable to possible negative shocks.
Why not now?
Many in the market have taken the view that a
restructuring of Greek debt is not only inevitable but
also desirable in the near term. On the inevitability
point, the Greek debt/GDP ratio could peak at 170%
or so. With no ability to devalue its own currency or
inflate its way out of its predicament, it will have to
run a primary budgetary surplus (that is a surplus on
government operations excluding debt interest) of
6% a year for a prolonged period to get the debt onto
a clearly sustainable path. Judging from the record of
accomplishment of other countries (excluding oil
producers), this may not be impossible, but it is
almost impossible.
The arguments used to support the “desirability”
argument are:
Paul Mortimer-Lee, Luigi Speranza and Eoin O’Callaghan
Market Mover
Chart 1: Greek Credit Institutions’ Domestic
Deposits
260
Greek Credit Institutions - Domestic Deposits (EURbn)
240
220
200
180
160
140
120
100
01 02 03 04 05 06 07 08 09 10 11
Source: Reuters EcoWin Pro
ƒ Postponing the inevitable will just make the
restructuring more painful in the future;
ƒ It is priced in and, as such, should not be a major
shock for the markets;
ƒ Additional financing to Greece implies moral
hazard and would further undermine political
support for bailouts in creditor countries; and
ƒ Restructuring would reduce market uncertainty by
forcing private creditors to crystallise their losses.
In essence, if it is inevitable, the argument goes, why
not get it over and done with now?
Restructuring costs
While we have sympathy for some of the above
arguments, we believe the costs potentially
associated with debt restructuring in the near term by
far outweigh the benefits.
i. First, debt restructuring would have severe
implications for Greek banks. As of February, Greek
credit institutions held EUR 48bn of general
government securities. A haircut to these would hit
bank capital – the majority of these bonds are not
marked to market (this is also true of banks outside
Greece). It would also have liquidity implications
because all of these bonds form part of the
EUR 145bn in collateral the Greek banks post with
the ECB to be able to borrow via its open market
repo operations. If the haircut was larger than the
ECB’s buffer (the market price less a haircut), these
banks would have to post additional collateral with
the central bank to maintain the same level of
borrowing.
12 May 2011
4 www.GlobalMarkets.bnpparibas.com
The banks’ pool of available collateral would, Box 1: Haircuts: How Much?
however, have shrunk. In addition to using their GGB
When evaluating by how much Greece should eventually hair
assets to fund themselves, Greek banks have also cut its bonds in the case of restructuring, it must be
used 1) government guaranteed liabilities and 2) considered that a significant and increasing part of the total
loans of bonds by the Greek government as debt is represented by the EU/IMF loan.
collateral. The first programme has a ceiling of some We assume that a haircut of the loan would be unfeasible.
EUR 85bn – recently increased from EUR 55bn, This means the burden on private creditors must be
presumably because issuance hit its ceiling. The comparatively higher. The table below provides an
government has also loaned banks EUR 8bn to aid illustration. In order to reduce the public debt-to-GDP ratio to
around 100% from 143% in 2010, for example, a haircut of
their funding operations. A restructuring by the 50% of privately held debt (including the ECB’s SMP) would
government would call into question the value of the be required. If the aim is to reduce the debt to 80% of GDP,
government guarantee on bank debt and reduce the the haircut needed is of around 70%.
value of the debt the government has provided to the
banks as a funding instrument. In theory, the
government could just guarantee more debt and Table 1: Greece - IMF Projections
transfer more loans to the banks given that neither 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
requires access to the market, but it would depend Primary Budget
Balance
on whether the ECB were happy to continue to (% GDP) -0.9 1.0 3.5 6.0 6.3 6.1 6.0 6.0 5.9 5.9
accept these instruments as collateral. Interest
Expenditure
(% GDP) 6.6 7.5 8.3 8.6 8.4 8.2 8.5 8.4 8.3 7.9
In sum, there are implications for bank capital and Budget Balance
liquidity even before you consider the risk of deposit (% GDP) -7.5 -6.5 -4.8 -2.6 -2.1 -2.1 -2.5 -2.4 -2.4 -2.0
Memo:
flight and other potential spillovers from a Greek Nominal GDP
default. Note that domestic deposits have already (EUR bn) 226.0 229.4 236.0 243.8 251.9 262.2 273.2 285.5 299.2 313.6
fallen by around 12% since late 2009 (Chart 1) but a Source: IMF
large part of this reflects the sharp nominal
Table 2: Greek Public Debt Under Different
contraction in the economy.
Assumptions of Haircut
ii. The ECB would also be vulnerable to a haircut on 2011 2012 2013 2014
Greek government debt via its holdings of Greek
IMF Estimates
debt in the Securities Markets Programme (SMP)
and, in a more adverse scenario of bank defaults, via EU/IMF Loan (EURbn) 78.0 102.0 110.0 110.0
the repo collateral it holds. Combined, these could Marketable Inst. (EURbn) 267.8 262.7 262.9 265.5
imply losses of over EUR 20bn, more than twice their
capital and reserves. Potential contagion effects to Total Public Debt (EURbn) 345.8 364.7 372.9 375.5

other countries could increase this loss. Public Debt (% GDP) 153.0 159.0 158.0 154.0

With 50% Haircut on Marketable Inst.

On the first exposure, assuming the average price of
the debt bought under the SMP was 80 cents on the EU/IMF Loan (EURbn) 78.0 102.0 110.0 110.0
dollar (the average price of the 10y bond between
Marketable Inst. (EURbn) 133.9 131.4 131.4 132.8
May and mid-July), a 50% haircut to the EUR 45bn
of debt held in this programme would imply a loss of Total Public Debt (EURbn) 211.9 233.4 241.4 242.8
around EUR 15bn. In a more adverse scenario, Public Debt (% GDP) 93.8 101.7 102.3 99.6
where restructuring causes widespread default in the
With 60% Haircut on Marketable Inst.
Greek banking system, the ECB would also be left
with the collateral the banks posted with it. As of EU/IMF Loan (EURbn) 78.0 102.0 110.0 110.0
February, the ECB was lending Greek banks Marketable Inst. (EURbn) 107.1 105.1 105.2 106.2
EUR 90bn on collateral of EUR 145 – an aggregate
haircut of around 35%. Assuming this is Total Public Debt (EURbn) 185.1 207.1 215.2 216.2

representative of the haircut applied to Greek Public Debt (% GDP) 81.9 90.3 91.2 88.7
government bonds, a 50% haircut would leave the
With 70% Haircut on Marketable Inst.
ECB with losses it is not protected for to the tune of
another EUR 7-8bn – even before you consider what EU/IMF Loan (EURbn) 78.0 102.0 110.0 110.0
the losses would be on 1) government-guaranteed Marketable Inst. (EURbn) 80.3 78.8 78.9 79.7
bank debt collateral and 2) debt securities collateral
Total Public Debt (EURbn) 158.3 180.8 188.9 189.7
loaned to the banks by the government.
Public Debt (% GDP) 70.1 78.8 80.0 77.8
iii. Restructuring would probably freeze Greece’s
Source: IMF, BNP Paribas
access to the market for at least two years. In the

Paul Mortimer-Lee, Luigi Speranza and Eoin O’Callaghan 12 May 2011

Market Mover 5 www.GlobalMarkets.bnpparibas.com
absence of additional financing from the EU, Greece Table 3: Banks' Exposure to Greece, Portugal,
would be forced to suddenly reduce public spending, Ireland and Spain (USDmn, end of Sep 2010)
with significant fallout on activity. Note that,
Nationality of Lender Greece Portugal Ireland Spain
according to the EU/IMF programme, Greece will
have a primary budget balance in 2012 (of 1% of Austria 3,312 1,746 3,472 20,351
GDP, Table 1). But interest payments would still Belgium 2,148 2,263 54,741 20,351
amount to 7.5% of GDP, leaving the overall balance
France 59,364 37,175 52,209 182,174
in deficit of 6.5% of GDP. Even assuming
restructuring halves interest payments, a significant Germany 40,253 39,970 154,059 200,939
sudden adjustment to public spending would be Ireland 8,474 5,747 - 27,207
required to balance the budget. This picture changes
significantly from 2013 onwards, as the primary Italy 4,815 4,842 15,798 28,047

surplus is expected to be 3.5% of GDP, a level Netherlands 4,592 6,133 22,564 78,862
potentially sufficient to offset the post-restructuring
Portugal 10,697 - 21,727 25,825
interest payment bill.
Spain 1,190 86,397 13,312 -
iv. Restructuring would also very probably reduce the Switzerland 3,619 3,465 19,389 14,699
urgency of, and therefore weaken the commitment
to, structural reforms. Aimed at increasing Greece’s UK 12,655 25,431 179,755 123,522
European Banks
growth potential in the medium term, these reforms Claims on Greece 153,553 215,894 564,531 726,914
are an essential part of the EU/IMF programme.
US 7,081 4,537 72,611 47,952

v. Debt restructuring would reopen the debate on Source: BIS Quarterly Review, March 2011

Greece leaving the eurozone. As the points above
emphasise, restructuring would probably lead to a
significant fallout on activity and jobs, and potentially
wipe out a good chunk of the Greek banking sector.
Under these circumstances, Greece might find it
beneficial to reacquire its ability to print money to
support the banking sector and devalue its currency
in order to gain competitiveness. We would argue
that most of the benefits of such an option would only
be temporary. The problem in Greece stems mainly
from real rigidities (such as the strictly regulated
labour market) rather than nominal rigidities. Against
this backdrop, currency devaluation leads to
increases in wages and prices, with a limited impact
on real competitiveness in the medium term. Yet this
might be the only possible route for Greece to avoid
the economy spiralling into deflation after a debt
restructuring. In turn, Greece exiting the eurozone
would risk sparking a run on banks in other
peripheral economies, with potentially systemic
implications for the eurozone banking sector as a
whole.
vi. But even not considering the extreme (and very
unlikely) hypothesis of Greece leaving the EMU, the
possible implications for the eurozone banking sector
of a debt restructuring in Greece could be significant.
According to BIS data (Table 3) claims of European
banks on Greece amounted to EUR 153.6bn as of
September 2010. Claims on Greece, Portugal and
Ireland are much higher at a combined USD 934bn.
Restructuring would force banks to recognise losses
in their banking books with potentially systemic
implications for the banking sector in the eurozone.
Not to mention that it would jeopardise the credibility
of the bank stress tests under way, as the
assumption of restructuring is not set to be tested.
Conversely, postponing the restructuring would allow
banks to strengthen their capital and/or spread
losses over a longer period of time, hence reducing
their potential impact.
vii. Last but not least, it could have significant
spillover effects on other countries that are
undergoing a significant fiscal adjustment, such as
Portugal, Ireland and even Spain. Allowing a
restructuring in Greece, after denying the possibility
for so long, could only lead the markets to revise up
the probability they would assign to restructuring
elsewhere, perhaps significantly. Market access for
Ireland and Portugal would probably fall significantly,
with the potential for a self-fulfilling prophesy or their
inability to return to the markets.
In order to be able to return to the markets as early
as possible, a Greek restructuring should aim at
reducing public debt enough to guarantee its
sustainability. We would therefore aim at a public
debt in the order of 80% to 100% of GDP (Box 1).
This would be lower than the public debt in Ireland
and probably Portugal, and lower than in countries
such as Italy and Belgium. Even if the circumstances
and the macroeconomic picture differ significantly
from those in Greece, this could fuel speculation that
other countries might follow. In turn, this could lead
to an increase in the risk premium, eventually
pushing the public debt of these countries on to an
unsustainable path over time, in a self-fulfilling spiral
typical of adverse debt dynamics.
In sum, the costs of restructuring before 2013 far
outweigh the benefits. Even if restructuring at some
point in the future eventually were the most likely

Paul Mortimer-Lee, Luigi Speranza and Eoin O’Callaghan 12 May 2011

Market Mover 6 www.GlobalMarkets.bnpparibas.com
option, there is value in postponing such a choice to
after the European Stability Mechanism (ESM) is
introduced in mid-2013.
What about debt reprofiling?
An alternative is a reprofiling of Greek debt (i.e.
lengthening of the maturity of the debt) on a
voluntary basis. Such an option would allow Greece
to significantly reduce its financing needs over the
next few years, limiting the need for additional
financial support from the EU/IMF. Under certain
conditions, debt reprofiling would not trigger a CDS
event, and would have limited fallout on banks’ hold-
to-maturity portfolios. Finally, it would probably
appease some of the opposition to more
concessions to Greece across creditor countries, as
private creditors would be seen to be playing their
part. It therefore appears a credible solution to
Greece’s funding problems over the next few years.
However, we would highlight a number of
counterarguments. First, in the absence of haircuts
and/or significant savings in terms of interest
payments, such an option would not change
significantly the market’s assessment of the
sustainability of Greece’s public finances. Second,
we would argue it would have a negative signalling
effect. If Greece were forced to resort to
rescheduling to overcome its short-term cash flow
problems, rather than secure additional funding from
the EU/IMF, it would implicitly suggest that the EU
and the IMF doubt the sustainability of the Greek
debt. The markets would therefore probably assume
that the voluntary debt reprofiling would be followed
by other forms of debt restructuring, next time
including a haircut. This could still have some
spillover effects on other peripheral economies.
Conclusions
To sum up, while it is difficult to see the market
changing its view that restructuring is eventually the
most likely outcome, we would argue that, in the near
term, the cost of such an option by far outweighs its
possible benefits, making it unlikely until at least
2013, when the ESM becomes operational. As many
in the ECB have warned, debt restructuring would
have negative implications for the Greek banking
sector and its economy. It would also risk having
systemic implications for the eurozone banking
sector and spillover effects for other peripheral
Paul Mortimer-Lee, Luigi Speranza and Eoin O’Callaghan
Market Mover
economies. Paradoxically, it is the weak position of
others that is the greatest defence against Greek
restructuring at the moment.
We are therefore confident that the EU and the IMF
will opt to lengthen the maturity of their loan and
possibly provide additional financial support to
Greece. This decision could be accompanied by a
voluntary reprofiling of privately held debt, though the
latter is more of a 50:50 bet against the near
certainty of more official money. While less dramatic
than a restructuring, this could still spark unwanted
spillover effects. But reprofiling would significantly
reduce Greece’s funding needs in the next two years
and appease the increasing opposition to the bailout
in some of the creditor countries, as private creditors
would be seen to play their part.
Therefore, we rule out, in the near term, the option of
debt restructuring with haircuts, given its high
potential costs. But the choice between the other two
options currently being debated (additional financial
support and/or debt reprofiling) is essentially political
and hence a close call.
We might find out more at the EcoFin meeting
scheduled for early next week. But, ahead of the
release of the EU/IMF quarterly review of the
programme, we doubt the finance ministers will
reach a definitive agreement.
Meanwhile, markets are likely to remain nervous,
because the crisis resolution mechanism established
by the EU still lacks the political consensus needed
to allow an effective response to unexpected shocks.
The ambiguity about whether creditor countries
(especially Germany) will extend funding is
necessary to ensure the peripheral countries
maintain their resolve to pursue a rapid adjustment.
But such uncertainty is a double-edged sword and is
bound to leave markets twitchy. Furthermore, since
the Greek worries are not purely about short-term
liquidity but also about longer-term sustainability,
those worries are unlikely to go away quickly.
Sentiment swings will remain an integral part of the
interaction between markets and politicians. What is
of concern is that we have not yet reached a decisive
turning point – the trend is for increased market
pessimism. Were this to continue, we would expect a
more convincing political response.
12 May 2011
7 www.GlobalMarkets.bnpparibas.com
Europe: On the Level
Chart 1: Levels of GDP
„ German GDP will soon rise above its pre-
(rebased, constant prices)
financial crisis peak.
„ In Italy, Spain and the UK, GDP is still 4-6% 100

G e rm any
below its pre-crisis high. 99

„ The German recession was deeper, and the 98

F rance

subsequent recovery stronger, than in the other 97

UK
countries, linked to the evolution of global trade.
96 Sp ain

„ Structural factors are also contributing to Italy

95
Germany’s growth outperformance.
94
R ebased :
10 0 = Q 1 2008
93
Nearly there Q1 Q2
08
Q3 Q4 Q1 Q2
09
Q3 Q4 Q1 Q2
10
Q3 Q4 Q1
11

German GDP is on the verge of rising above its peak

Source: Reuters EcoWin Pro
level seen before the global financial crisis. As of Q4
last year, seven quarters after the economy hit Chart 2: Levels of Exports
bottom, GDP on a constant price basis was 1.4% (rebased, constant prices)
below its high in Q1 2008. There is an outside
chance that the previous peak will be surpassed as 100
Germ any

soon as Q1 this year: our forecast is for a quarter-on-

quarter rise in GDP of 1.0% but a higher growth rate 95

is possible. The ‘flash’ estimate of Q1 GDP will be UK Spain

released on 13 May. 90

Chart 1 shows the evolution of GDP on a constant 85 Fran ce Italy

price basis in the four largest eurozone countries,

plus the UK, relative to its peak in Q1 2008. The 80

GDP series have all been rebased, with Q1 2008 R ebased:

100 = Q1 2008

equal to 100. 75
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
08 09 10

France is in a similar position to Germany currently, Source: Reuters EcoWin Pro

with GDP in Q4 last year around 1.6% lower than its
pre-crisis peak. We are forecasting a quarter-on-
quarter rise in GDP in France, also out on 13 May, of
0.8%.
The picture in the other countries, however, is very
different. In Italy, Spain and the UK, GDP is currently
5.2%, 4.3% and 4.1%, respectively, below the peak
levels reached in Q1 2008. (The data for the UK is
one quarter advanced on the other countries, with Q1
GDP having risen by 0.5% q/q.)
The bigger they are…
So what accounts for the differences? In Germany’s
case, a key part of the story is the exceptional depth
of the recession during the financial crisis. Over the
four quarters before Q1 2008, German GDP
collapsed by a cumulative 6.6%. This compares with
cumulative declines in GDP in Germany of around
3.5% and 2%, respectively, during the recessions of
the early 1990s and 2000s.
As we have highlighted in previous notes, Germany’s
high sensitivity to developments in global trade was
the key reason for its exceptionally deep recession –
reflected in the unusually high share of GDP which is
accounted for by exports (over 50%). As global trade
collapsed amid the panic over the demise of Lehman
Brothers, so too did German exports and GDP.
Once confidence stabilised and global growth began
to recover, from spring 2009, Germany felt the
benefit very quickly. As the Kurzarbeit scheme (cuts
in working hours, with reductions in workers’ incomes
topped up by government payments) had allowed the
corporate sector in Germany to retain the bulk of its
labour force, output was able to respond swiftly to the
rebound in global demand.
The level of German exports in real terms overtook
its pre-crisis peak in Q4 last year (Chart 2). Monthly
trade data already released point to a further strong

Ken Wattret 12 May 2011

Market Mover 8 www.GlobalMarkets.bnpparibas.com
rise in exports in Q1: the first expenditure breakdown Chart 3: Levels of Private Consumption
for Q1 GDP will be released on 24 May. (rebased, constant prices)
104
As Chart 1 illustrates, the cumulative contractions in France
GDP during the financial crisis were typically smaller 102
than in Germany, even in the countries which were G erm any

most vulnerable to problems in the financial sector, 100

such as the UK. The same is true of the US, whose Italy

housing and banking sectors were at the epicentre of 98

the crisis but whose GDP declined by a cumulative 96

UK

4% from peak to trough, two-thirds the magnitude of

S pain
the contraction in Germany. 94
Rebased:
Q 1 2008 = 100

In part, the difference reflects the dampening effect 92

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
on the contractions in GDP of collapsing imports, as 08 09 10

domestic demand fell off a cliff. This is particularly

Source: Reuters EcoWin Pro
true of Spain. The fall in domestic demand in Spain
has been roughly twice as big as the fall in GDP.
Consumer contrast
Italian exception
The evolution of private consumption is also pivotal
Italy is a conspicuous exception to the rule that the
to the variation of economic performance across the
deeper the recession, the stronger the recovery. The
major European economies. In France, consumption
cumulative decline in GDP in Italy from its peak in
has been remarkably robust before, during and after
Q1 2008 to its trough in Q2 2009 was almost 7%,
the financial crisis. As of Q4 2010, consumption was
bigger even than in Germany. But the rebound has
3% up on Q1 2008’s level (Chart 3). A lower saving
been much less impressive than in Germany, with
rate and loose fiscal policy have been supportive,
the level of GDP as of Q4 2010 still more than 5%
though the latter will become more of a headwind
below its pre-crisis high.
beyond the presidential election in 2012.
In large part, this is due to the poor performance of
In contrast, private consumption in Spain and the UK
Italian exports. While, in Germany, the level of
remains 4-5% below Q1 2008’s level. Since mid-
exports is now above its pre-crisis peak, in Italy, the
2009, there has been a modest pick-up in the level of
level of exports is still over 14% below its high point
spending in both countries. But, given the persistent
in Q1 2008 (Chart 2). Boosted by export strength, the
growth headwinds in both (e.g., tight fiscal policy,
average quarter-on-quarter rise in German GDP
high household debt), a return to pre-crisis levels of
since the bottom of the cycle in Q1 2009 has been
spending is a long way off, raising doubts about the
0.8%. In Italy, it has averaged just 0.3% q/q.
sustainability of their recoveries.
The geographical composition of German and Italian
In Germany private consumption was stagnant
exports is a contributory factor to the divergence of
during the expansion from 2006 to 2008 but some of
export performance between the two countries. The
the factors restraining spending – e.g., a lesser
share of German exports which go to the faster-
propensity to build up debt – were helpful once the
growing developing markets, particularly China, has
crisis struck. The Kurzarbeit scheme also played a
been trending higher for over a decade but has
part, helping to insulate the household sector from
stepped up a gear since the financial crisis. Demand
job losses and limiting the decline in incomes. The
in the western world is constrained by past excesses
unemployment rate rose by less than a percentage
but growth in developing economies has been fuelled
point during the crisis and, at 7.1% currently, it is half
by exceptionally stimulatory policy.
a point below its pre-crisis low. That consumption
China accounts for around 6% of German exports at accounts for a comparatively low share of German
present and, at one stage last year, roughly a quarter GDP (55% at present) is also significant.
of all German export growth was due to China. China
accounts for around 2.5% of Italy’s exports. German The average quarter-on-quarter increase in private
exports to China total about EUR 5bn, over six times consumption in Germany in the three quarters to Q4
the size of Italy’s exports to China. 2010 was 0.4%, the highest in four years. The
prospect of stronger employment growth (signalled
Were it not for the multitude of problems elsewhere by surveys), a rise in wage growth (with the
in the eurozone at present, we would expect financial unemployment rate below the NAIRU), a
markets to be paying considerably more attention to comparatively solid fiscal position and low interest
the meagre rebound in Italian GDP and exports since rates suggest that Germany is best placed to sustain
the recovery started in spring 2009. consumption growth ahead.

Ken Wattret 12 May 2011

Market Mover 9 www.GlobalMarkets.bnpparibas.com
France: Q1 Deficit is Smaller than it Looks
Chart 1: Central Budget Balance
„ The central government deficit widened, but
ignoring distortions, the trend is actually down. 0

„ Tax income is recovering faster than the -20

2011
government had expected. -40

„ Apart from the rising cost of public debt, the -60

2008
risk for expenditure remains moderate. -80
2009 2010
-100
„ The 2011 deficit is on track to meet the
-120
downwardly revised target.
-140
EUR bn. cumulative
-160
At first glance (Chart 1), the French budget deficit Jan. Mar. May July Sept. Nov.

worsened to EUR 33.6bn in Q1 compared with the

Source: Reuters EcoWin Pro
same period last year (EUR 28.9bn). However, the
details of the monthly statement suggest a very Chart 2: 2009 Income (% y/y)
different picture. Since we now have three months of
data, the figures are reliable. 2009 Net Receipts
(% y/y)
Net Tax Receipts
Income: recovery continues
Non Tax Receipts
In 2008, total income fell 2.7% y/y, as the start of the
economic slowdown weighed, in particular on Other Taxes
corporate tax (the December payment declined by Tax on Oil Products
EUR 3.7bn). The real drop occurred in 2009 when
total receipts fell another EUR 53.9bn or 18.5% y/y VAT

(Chart 2). Even the strong recovery in 2010 Corporate Tax

(15.9% y/y, Chart 3) left total income more than 8%
Income Tax
below the 2007 level. It is thus not a surprise to see
fiscal income posting solid gains again this year. -60 -50 -40 -30 -20 -10 0

Source: Reuters EcoWin Pro

The main source of strength is corporate tax, which
is up 38% or EUR 2.3bn in Q1. This gain follows a Chart 3: 2010 Income (% y/y)
57.2% jump last year. However, the Q1 2011 rise is
2010
still a third lower than that seen in Q1 2008 as the (% y/y)
Net Receipts

corporate tax take has yet to recover from its 57.5% Net Tax Receipts
collapse in 2009. Companies’ profitability has yet to
Non Tax Receipts
return to 2007 levels and corporations are allowed to
use past losses to reduce the tax on profits in the Other Taxes

following four years, so corporate tax income has yet +138%

Tax on Oil Products
to return to pre-crisis levels. The rise in Q1 is above
VAT
the full-year target of a 36% gain. We believe this
target could be exceeded and may have been Corporate Tax
reached by as early as April. The 2011 corporate tax Income Tax
income may be 10% below the 2007 level, although
the government expects it to be 12% lower. -10 0 10 20 30 40 50 60
Source: Reuters EcoWin Pro
Household income tax fell heavily in 2009 (-9.8%)
and started to recover in 2010 (1.7%). The Q1 2011
receipts are up 3.1% from last year, a pace of gain the government's target of a 10% rise is a long way
that is likely to be maintained until August. We expect off, it still looks realistic.
to see most of 2011’s gains in the last four months of
the year, since payments made until August are VAT income also gained a solid 5.4% or EUR 1.6bn
actually based on the preceding year’s tax. Although in Q1, which is nearly back to the Q1 2008 level. We

Dominique Barbet 12 May 2011

Market Mover 10 www.GlobalMarkets.bnpparibas.com
expect the full-year figure to reach about 5.0% (with Chart 4: Central Government Income
nominal consumption up 3.9% and shorter payment Breakdown 2010 versus 2008
delays). The government’s target is a rise of 2.8%.
2010
Combined, corporate tax, household income tax and
VAT represented more than 75% of total income 6.3% 7.9% Income Tax 6.7%
18.0% 11.7% 17.5%
even in the depths of the recession. The
5.6% Corporate
5.2%
normalisation of tax receipts could still help reduce Tax

the central budget deficit considerably this year. VAT

Tax on Oil
Expenditure still needs to be controlled tightly Products

The expenditure side is still distorted by two factors. Other Taxes

17.1% 12.1%
Firstly, the introduction of new software in 2010 Non Tax
caused delays in government expenditure payments 45.1% income
46.8%
in Q1 last year, artificially worsening the year-on-year
comparison. Secondly, subsidies paid to local Source: MoF, BNP Paribas
authorities to compensate them for corporate tax
reforms caused the deficit to increase temporarily in Chart 5: Breakdown of Public Expenditure
2010. As the second factor outweighs the first, it (% of GDP, 2010)
looks as if expenditure declined by 4.5%, but this is
2010
misleading, as much of the 5.3% rise in spending 0.6% 3.0%
2.6%
5.7%
excludes subsidies to local authorities. Investments

However, we are confident there will be no significant Debt burden

overshoot. There are no general wage increases this 13.3% Wages

year and restrictive measures have been put in place
Consumption
to control expenditure on health. The cost of
unemployment benefit will decline this year and Social benefits
pension reform will also start to have a positive effect
25.5% Subsidies
on public finances in the second half of the year.
Social benefits and the remuneration of public-sector 5.5% Others
employees are the main sources of public spending,
which amounted to 56.2% of GDP in 2010. Source: MoF, BNP Paribas

The main concern is the debt burden, which

increased 3.1% y/y in Q1 because of the rise in
short-term yields. This will worsen over time: higher
long-term debt implies higher coupon payments in
April and October. Higher inflation will also push up
the cost of inflation-linked debt, on which coupons
are paid in July. Altogether, we forecast the debt
burden to increase by about 10%, which is higher
than the government’s estimate of a 5.7% rise.
Conclusion
The government may have to tighten public spending
and subsidies further in order to hit its overall
spending target. Alternatively, it could rely on higher
fiscal income to keep the deficit in line with its
downwardly revised target of 5.7% of GDP.
The widening of the deficit in the first quarter stems
from the government’s decision to transfer a part of
subsidies and fiscal income to local authorities before
the tax income is actually received (most will be paid
in toward the end of the year). With some local
authorities still finding it difficult to get bank loans, it
is easier and cheaper for the state to provide the
financing. This early transfer of funds will have no
impact on the year-end deficit.
The deficit also increased due to the payment of the
first 2011 tranche of funding to Greece (for
EUR 3.1bn in March). This payment came on the top
of the last tranche of 2010 funding, which was
delayed from December to January (EUR 1.4bn).
Altogether, these payments add 0.2pp of GDP to
France’s deficit and debt (as well as those of other
eurozone countries). However, this was partly
compensated for by the early redemption of a rescue
loan to the auto industry.
The analysis of Q1 accounts shows that France is on
track to meet its deficit target in 2011, or even
undershoot it, for the third year in a row. However,
aggressive spending cuts will be needed to meet the
2012 target. The determination of the government is
undeniable, as shown by the lower house’s voting for
a law to prepare for the introduction of a golden rule
in the French constitution, similar to Germany’s
introduction of a “debt brake” (see “France
Obstinately Seeking Credibility”, Market Mover,
10 February 2011). The upper house will discuss the
law on 14 June, though the change to the
constitution may be delayed until after the elections.

Dominique Barbet 12 May 2011

Market Mover 11 www.GlobalMarkets.bnpparibas.com
UK: Bank Balance
Chart 1: Sources of Inflation
„ The market may have overreacted to the
upward revision to the Bank’s inflation forecast
– if a good chance of 5% inflation isn’t enough
to prompt a rate hike, what is?
„ The Bank continues to see high current
inflation as largely due to temporary factors.
„ Growth data are sufficiently weak and
growth prospects sufficiently uncertain to
justify a “wait and see stance”.
„ A mistimed rate hike could jeopardise fiscal
consolidation prospects and shake the coalition
government if it led to a double dip.
Source: Bank of England
„ We have two rate hikes in our forecast but
have been contemplating removing them due to Chart 2: GfK Measure of Consumer Confidence
our increased perception that the Bank will only
hike if it absolutely has to.
„ The key uncertainties about UK rates are a
messy picture on the real economy data, and
doubt about the Bank’s reaction function.
„ While headline inflation rates may grab the
headlines, the key things to watch are cues
about the reaction function in the minutes,
indicators of momentum in the real economy
such as the CIPS surveys, and wages. While
wages remain subdued, worries about
domestically generated inflation will remain
Source: Reuters EcoWin Pro
contained inside Threadneedle Street.

The majority of forecasters also appear to view the

The markets’ initial reaction to the latest Bank of
England Inflation Report was to revise upwards the
probability of a hike in Bank rate by the end of this
year (priced as 95% probable at the time of writing).
Sterling rose sharply and the gilt market sold off
immediately after the press conference. Our initial
take was that the markets’ reaction was overdone.
Below, we explain why.
shift in the inflation forecast as reinforcing the case
for a near-term rate rise. We see it rather differently,
in terms of what the latest developments tell us about
the reaction function of the Bank of England. In other
words, if the most likely outcome is for 5% inflation in
the period ahead and yet the MPC still chose not to
tighten policy, what would it take to prompt a rise in
interest rates?

Five alive Looking through

Why did the market react the way it did? In short,
because the Bank of England’s projection for inflation
was revised markedly upwards, with a "good chance"
that the CPI inflation rate will hit 5% before the year
is out. Inflation is now expected to remain above the
2% goal throughout 2011 and 2012.
Another consideration is that markets had already
priced out a considerable amount of policy tightening
since the previous Inflation Report in February.
The inflation rate has been uncomfortably high in the
UK for a long time now and the Bank of England has
repeatedly shown its willingness to look through it,
focusing instead on the medium-term prospect of the
inflation rate falling back to the target level.
This was again the conclusion of the latest Inflation
Report: i.e. that the impact of external price
pressures and VAT hikes will dissipate which,
combined with the margin of spare capacity in the

Kenneth Wattret, Paul Mortimer-Lee 12 May 2011

Market Mover 12 www.GlobalMarkets.bnpparibas.com
economy, will see inflation head back to the desired
2% rate over the two-year horizon.
We reproduce here one of the key charts from the
Inflation Report (Chart 1). It shows that domestically
generated inflation is around zero and that virtually
all the inflation currently being experienced is from
VAT, energy and import prices. Against this
background and with wages rising slowly, it is hardly
surprising that the Bank should conclude that future
inflation will fall to close to target once some of the
short-term shocks have dropped out of the twelve-
month comparison.
As with the previous Inflation Report three months
ago, the MPC concluded that there was an equal
chance that inflation will be above or below the 2%
objective over the medium term.
The discussion of the upside risks, including higher
inflation expectations and faster wage growth, and
the downside risks, including the impact of higher
spare capacity on domestic price pressures, was a
familiar one.
Uncertainty key
The Governor was explicit in the press conference
that Bank rate would have to go up “at some point”.
He was equally explicit, however, that when this will
happen remains highly uncertain. Indeed, one of the
recurring themes of the analysis from the Bank of
England is the unusually high level of uncertainty
over how things will pan out from this point. We note
that, generally, uncertainty is a recipe for central
banks to do nothing, awaiting clarification of the way
things will go.
We see this as particularly important in terms of how
the economy fares from this point on. While the Bank
of England’s view is that the underlying performance
of the economy is somewhat better than the Q1 GDP
figures implied (a view we also expressed after the
GDP release), at the same time there is probably
increasing concern at the loss of momentum in some
recent leading indicators. The April CIPS surveys in
particular have pointed to a marked deterioration in
the economic situation. Consumer confidence also
looks miserable – a consequence of prices going up
twice as fast as average earnings. Having said that,
next week’s retail sales figures may look better, but
we reckon that the warmest weather since records
began in 1659 and the Royal Wedding may have
given an artificial boost to these. Additionally, base
effects will boost the year-on-year change. The
underlying consumer picture is weak.
With the prospects for the trend in private
consumption looking bleak, of particular concern is
the slump in the CIPS survey for manufacturing.
Kenneth Wattret, Paul Mortimer-Lee
Market Mover
Hopes have been resting on this sector as an offset
to what are expected to be persistent headwinds to
consumer demand. While the Bank’s Governor,
Mervin King, described the weakness as a “soft
patch”, implying that it will be short-lived, we suspect
that it will prove to be more persistent as the fiscal
squeeze progressively bites. One bit of evidence in
favour of the Governor’s line come from the Bank of
England Agents’ reports which have shown a pick-up
in hiring intentions in the manufacturing sector and a
still buoyant picture for exports. The Bank’s bet is
presumably that the hike in VAT in January has
depressed consumption but that this effect will fade
and so demand for manufactures from the domestic
sector will pick up.
Given the combination of the recent deterioration in
some activity indicators and high uncertainty over the
outlook, the likelihood is that the majority of MPC
members will continue to take a “wait and see” view.
Uncertainty surrounding developments in the MENA
region, oil prices and supply disruptions as a knock-
on from the Japanese earthquake lean towards the
same conclusion. We are concerned that the unusual
holiday patterns at the end of April – the latest Easter
since 1943 and the Royal Wedding/May Day Bank
holidays the next weekend - will have encouraged
people to bring forward holidays to April (to take 11
days away from work at the cost of only 3 days’
leave) - and so will have depressed Q2 output. The
picture may not clear as soon as people would hope.
Also we note that despite talk of cuts, government
spending rose in Q1 at 0.7% q/q. There may have
been an element of “use it or lose it” at the end of the
financial year and it is possible that Q2 government
spending looks weaker.
A major worry in the Bank should be that with
consumer so weak and with confidence very fragile a
rise in interest rates, especially if it engendered
expectations of more to come, could fracture what is
still a tentative recovery in the UK.
This leads on to the political/fiscal situation. The
Bank of England should be very wary of pushing the
economy into a double-dip recession as this would
look like a policy mistake. Moreover, if the economy
were to go into a double dip, the fiscal plans might
look unrealistic and political pressures on the
government would mount. The stability of the
coalition government could be threatened.
If it were to come to a bald choice between missing
the inflation target for a bit longer and jeopardising
the fiscal consolidation, the wise choice would be to
choose the former as the less unpalatable of the two
options. Though not presented as such, we see this
as a significant influence on the unwillingness of the
Bank of England to raise rates to date. If there is a
12 May 2011
13 www.GlobalMarkets.bnpparibas.com
debate on these issues within the Bank, we would Chart 3: Pay Settlements
guess it would be dressed up in the garb of “what is 4 .5
the optimum speed of disinflation in the UK?” Since 4 .0
U pper Q uartile

the Bank already expects inflation to come down next

3 .5
year, the argument for slowing the economy to hit the
inflation target quicker or with more certainty is a 3 .0
M ed ian
relatively weak one, especially if the potential costs 2 .5
Lo we r Q u artile

of a quick adjustment were high. The best case for a 2 .0

rate hike is to contain inflation expectations. 1 .5

1 .0
Bottom line
0 .5
At the time of writing, the market is pricing in just two
0 .0
25bp rate hikes by mid-2012. Our forecast has also Dec
05
A pr A ug D ec
06
A pr A ug D e c
07
Apr A ug D ec
08
A pr A ug D ec
09
A pr A ug D ec
10 11
been for two 25bp hikes, but much earlier: in August
and November this year, in tandem with the next two Source: Incomes Data Services
Inflation Reports, by which time inflation should be
much higher than it is now.

Our rationale for forecasting just two hikes has been

that we saw a tightening as a way of demonstrating
that the Bank of England was serious about
delivering on its inflation objectives. In other words,
we forecast a symbolic policy tightening designed to
keep a lid on inflation expectations rather than a
prolonged series of rate hikes aimed at squeezing
domestic price pressures – which, at least for now,
have remained contained. Fiscal tightening, after all,
will probably be enough – maybe more than enough
– to stop the economy running too hot. We took the
view that if the rate hikes were to come, they would
be more likely to arrive when inflation was high and
threatening inflation expectations rather than when it
was coming down appreciably next year.
We have been contemplating withdrawing our
forecast for rate hikes, however, given that the Bank
of England has demonstrated its willingness to
continue to look through high inflation by keeping
policy unchanged despite overshooting the 2% level
by an increasing margin for such a long period.
More evidence of weakness in the economy would
markedly increase the likelihood of a “no change”
outcome over the remainder of the year in our view.
In such circumstances, Bank rate could stay at 0.5%
for a considerable period as inflation will start to
come down during the first half of 2012 and the
urgency to raise rates will diminish accordingly.
What to watch
In the period ahead, the minutes to this month's MPC
meeting, to be published on 18 May will clearly be
important to how the markets see the outlook.
Beyond that, we will keep a particularly close watch
on the momentum indicators, such as the CIPS
surveys, and pay trends.
Pay settlements have been picking up (Chart 3) but
from a low base and are below the level cited by the
Bank of England in the past (4.5%) as consistent with
the inflation goal. Moreover, the Bank makes the
case in the Inflation Report that the upward drift in
settlements may be due to pay increases under
multi-year deals that have an element of indexation
rather than to an actual step up in wage increases
under new settlements. With labour costs accounting
for roughly two thirds of costs in the economy, a
significant upward move in wages would be required
to threaten the long term prospects for UK inflation. If
there is a current indicator that deserves close
attention as a guide to the Bank’s future actions it is
wages, not headline inflation.

Kenneth Wattret, Paul Mortimer-Lee 12 May 2011

Market Mover 14 www.GlobalMarkets.bnpparibas.com
Norway: Hiking Cycle Resumes
Chart 1: Policy Rates (%)
„ The Norges Bank delivered a 25bp rate hike
at its May meeting, taking the policy rate to
2.25%, in line with market expectations.

„ The Bank’s policy statement was upbeat on

growth, while it noted that inflation is expected
to pick up.

„ Overall, the Bank is likely to continue with

further, but gradual, rate hikes this year.

„ We continue to expect the next rate hike to

come in Q3, with the policy rate reaching 2.75%
by year-end.
Source: Reuters EcoWin Pro

Rate-hike cycle resumes

Following a rate hike last May, the Norges Bank
increased its key policy rate by 25bp to 2.25% a year
later, in line with our expectation. The Bank noted
back in March that “the key policy rate should be
increased before the end of the first half-year”. The
fact that economic developments have been, on
average, broadly in line with its expectations since
then led to a rate hike at the May meeting.
Strengthening in economic growth
Once again, the Bank noted the upturn in the
Norwegian economy, which “has gained a firm
footing”. We have highlighted before that, as
advanced country central banks, such as the ECB,
have already started to hike rates, the Norges Bank
will be more confident in delivering rate hikes. This
point was particularly mentioned in the statement,
with the ECB and the Riksbank rate hike increases
noted.
The language on inflation, however, was somewhat
dovish compared to the previous statement in March.
The Norges Bank stated that inflation is “low” and
this, together with a strong krone, suggests that the
policy rate should be kept low (although it was also
noted that “there are prospects that inflation will pick
up over the year ahead”). The inclusion of these
points in the statement might be intended to prevent
a significant upward shift in market expectations for
rates ahead, which might also lead to an upward
pressure on the krone.
That said, this does not mean the Bank will not
proceed with further rate hikes. Back in March, the
Bank explicitly noted that its new rate projections
suggested an increase in the key policy rate of 75bp
by the turn of the year (in line with our forecast that
the policy rate will reach 2.75% by the end of this
year). So, overall, the Bank’s projections suggest
further but gradual rate hikes this year.
The May policy statement and the Bank’s general
assessment also signal further rate hikes this year. In
particular, the Bank emphasised:
ƒ Capacity utilisation appears to be close to a
normal level;
ƒ House prices have risen;
ƒ There has been a sharp increase in housing
starts; and
ƒ Wage growth will be broadly in line with its
projections or somewhat higher this year.
Conclusions
Overall, given the strengthening in economic growth,
rising house prices and improvement in the labour
market, we expected this rate hike. Moreover, we
believe more is to come. The key policy rate, now at
2.25%, is still low compared to the neutral rate of
around 5% in Norway.
Our forecast for the Norges Bank is for 25bp rate
increases to come in each quarter this year.
Following the May decision, we continue to expect
the next rate hike to come in Q3 – earlier than the
Norges Bank’s projection of a rate hike in October.
We expect this rate hike to come in September, with
a risk of it coming earlier. If the krone does not
appreciate significantly and economic data surprise
markedly to the upside, in particular inflation, credit
growth and developments in the labour market, a
rate hike could come as early as August.

Gizem Kara 12 May 2011

Market Mover 15 www.GlobalMarkets.bnpparibas.com
US Employment: Stock and Flow
Chart 1: Private Hiring Continues to Strengthen
„ Nonfarm payrolls were well above
expectations in April while the unemployment
rate jumped to 9.0% on a weak household
survey – NOT a rebound in the participation
rate.
„ The strong hiring numbers provide a solid
base of support that will enable the US economy
to weather the blows from rising food and
energy prices, and production disruptions
related to events in Japan.
„ The elevated unemployment rate and an
employment/population ratio highlight that the
US economy is still operating at a speed limit Source: Reuters EcoWin Pro
well below prior norms. The report therefore
does not change our expectations for Fed policy Chart 2: Most Indicators Were Pointing to a
as the Fed is focused on the amount of slack in Moderation
the labour market, which is still excessive.

The April jobs report was a mix of surprises with job

growth much stronger than expected while a weak
household survey led to a jump in the unemployment
rate. The flow of hiring has been impressively robust
of late but the unemployment rate provided a
sobering reminder of how far we have to go. The
strength in hiring was a surprise given the uniform
weakness in recent hiring indicators. While the
details of the jobs report were solid, markets were
unsure how to read the tea leaves. The stock market Source: Reuters EcoWin Pro
initially surged on the news but ended the day only
modestly higher. It appears that the continued Chart 3: The Unemployment Rate Ticked Up
uncertainties about the European situation and the
impending end of QE2 outweighed the signal from
the April jobs report.

Nonfarm payrolls surprised to the upside in April with

a net gain of 244k after a 221k increase in March.
We had looked for a significant moderation in the
pace of hiring on the basis of an across-the-board
weakening in hiring indicators including ISM surveys
and jobless claims (Chart 2). In contrast, the
unemployment rate jumped to 9.0% from 8.8% as the
household survey showed a decline of 190k jobs.
The participation rate was unchanged at 64.2% so a
Source: Reuters EcoWin Pro, BNP Paribas
rebound in participation was not the driver of the
increase.

The strength in hiring was concentrated in the private

sector as the government shed 24k workers. The weak dollar continues to benefit the leisure and
goods-producing sector added 44k jobs in hospitality industry, which added 46k workers after a
manufacturing and mining. The private service sector 51k gain. Retail added a whopping 57k workers after
added 224k after a 194 gain the previous month. The a loss of 3k, and education and health care added

Julia Coronado 12 May 2011

Market Mover 16 www.GlobalMarkets.bnpparibas.com
49k after a 33k increase. Average hourly earnings Chart 4: The Household Survey Was Weak
rose 0.1% m/m after an upward revised 0.2% gain,
leading the annual pace of earnings for private sector
workers to edge down to 1.9% from 2.0%.

To clarify a point of confusion in the report; nonfarm

payrolls come from a survey of more than 200k firms.
The unemployment rate is generated from the
household survey, which queries about 30k
households. The unemployment rate rose to 9.0%
from 8.8% because the population grew while
employment actually declined in the household
survey (Chart 4). The participation rate was
unchanged. These discrepancies between household
and establishment surveys are common occurrences
Source: Reuters EcoWin Pro
and do not necessarily have much information
content – one does not reliably lead the other and the Chart 5: Employment/Population Still Low
household survey is even more volatile than the
establishment survey. Over the past three months
the household survey shows an average gain of 117k
while the payroll survey shows 233k. In February and
March the household survey had been running
ahead of the establishment survey. The bottom line
is that the underlying labour market is probably a
balance of the two – the rise in the unemployment
rate is telling us something about the pace of
improvement in the labour market (i.e. pretty slow)
while the payroll survey is telling us that the
foundation of hiring is broadening and strengthening
– a good thing in light of all the other blows
consumers have to absorb.
Source: Reuters EcoWin Pro, BNP Paribas

On balance, the report confirms an improving trend in

the labour market. The unemployment rate had
dropped unusually sharply over the previous four
months so a retrenchment is not a huge surprise and
highlights the gradual nature of the labour market
improvement. Nonetheless, the quality of hiring has
improved in recent months with more permanent full-
time and less temporary and part-time workers.
Wage growth has stabilised just below 2.0% y/y.
Aggregate hours worked rose 0.3% m/m, leaving the
3m annualised growth in hours at 3.5%. Combining
this with wage growth, the report points to solid gains
in wage and salary income, although at a pace just
about in line with headline inflation for Q2. Since
most survey indicators had pointed to a moderation
in hiring, some slowing may still be in store as Q2
unfolds, although from a more solid foundation.
While the momentum in hiring serves to reinforce
confidence that the private sector is on a more solid
footing, the speed limit of the economy is still well
below prior norms. This is highlighted by the fact that
the ratio of employment to population (Chart 5) is still
near the lows reached during the recession. Job
creation has kept pace with population growth –
nothing more to date. This suggests that each
paycheck is still spread fairly thin. The report
therefore does not change our expectations for Fed
policy as the Fed is focused on the amount of slack
in the labour market which is still excessive.
Chairman Bernanke has highlighted that the Fed
anticipates a further significant improvement in the
labour market and the April report would not seem to
exceed those expectations, particularly given the rise
in the unemployment rate.

Julia Coronado 12 May 2011

Market Mover 17 www.GlobalMarkets.bnpparibas.com
Japan: GDP to Contract in Q1 on Earthquake
Chart 1: Economic Forecasts
„ While the earthquake occurred late in the
quarter, the plunge in activity after 11 March will 2010 2011
Q4 Q1
probably have pushed growth in Q1 into Contribution
q/q q/q Annualized
negative territory. Real GDP q/q - 0.3 - 0.8
to GDP
- 3.0
y/y 0.0 0.3
„ We expect real GDP to have contracted Contribution of Domestic Demand - 0.2 - 0.6 ( - 2.3 )
0.8% q/q (-3.0% annualised) in Q1. Contribution of Private Demand 0.0 - 0.7 ( - 2.7 )
Contribution of Public Demand - 0.2 0.1 ( 0.4 )

„ With the outlook for power supply over the Contribution of External Demand
Private Consumption
- 0.1
- 0.8 - 0.5
- 0.2
- 0.3
( - 0.7 )
- 2.0
summer having improved, we have made Private Housing Investment 2.9 2.2 0.1 9.1
Private Capital Spending 0.5 - 1.3 - 0.2 - 5.1
provisional upward revisions to our growth Stocks (Cont to Growth) 0.3 - 0.3
forecast. Government Consumption 0.3 0.8 0.2 3.2
Public Fixed Investment - 5.6 - 1.2 - 0.0 - 4.7

„ We now expect the economy to contract Exports

Imports
- 0.8
- 0.1
- 0.7
0.4
- 0.1
- 0.1
- 2.8
1.6
0.5% q/q in CY 2011 (-1.2% before) and the Nominal GDP q/q 0.6 - 0.9 - 3.7
GDP Deflator y/y - 1.6 - 1.8
recovery in CY 2012 to be moderate at 1.9%
(1.6% before). Source: Cabinet Office, BNP Paribas. Note: data for Q4 2010 are actual.
„ Our cautious outlook reflects our concern
Chart 2: Industrial Production (2005=100)
over the knock-on effect of supply constraints
on the demand side and the outlook for power 120
supply over the medium term. (*) Figures for Apr-May
2011 are estimated using forecast index.
110

100
We expect the Cabinet Office's preliminary GDP data
for Q1 2011, due on 19 May, to show a sharp
90
contraction of 0.8% q/q (-3.0% annualised), for a
second straight quarter of negative growth (-0.3% q/q,
-1.3% annualised in Q4 2010). 80

The economy had appeared to be turning around 70

after the sluggishness of Q4, itself induced in part by
policy factors (pullback in consumer spending
following a Q3 surge linked to a cigarette tax hike
and the expiry of the "eco car" subsidies). Exports
started reviving in late 2010 on the back of the
recovery in global manufacturing.
However, the level of economic activity plummeted
after the Great East Japan Earthquake on 11 March,
due to supply constraints in the form of disrupted
supply chains and reduced power supply.
The economy was also hit by a sharp deterioration in
sentiment, which led households and businesses to
cut back sharply on spending. While the earthquake
occurred late in the quarter, the contraction in activity
after 11 March will probably be enough to push the
growth rate in Q1 deep into negative territory.
Net exports to have negative contribution
We expect exports to have contracted 0.7% q/q
(-0.8% q/q in Q4), for a second straight decline, as
the nascent revival in exports was quashed by
diminished capacity to produce export goods
07 08 09 10 11
Source: METI, BNP Paribas
following Japan’s worst-ever natural disaster. Imports,
on the other hand, rose 0.4% q/q (-0.1% q/q in Q4),
as spill-over from the disaster was limited: most
imported goods were en route when the quake hit.
Taken together, net exports should make a negative
GDP contribution of 0.2pp (-0.1pp in Q4).
Domestic demand sapped by supply constraints,
weak sentiment
We estimate that private consumption contracted
0.5% q/q (-0.8% q/q in Q4), for a second straight
drop.
Household spending was showing signs of picking up
alongside improving economic sentiment and
employment/income conditions from the start of 2011.
However, the disaster quickly turned sentiment sour,
causing a national mood of self-restraint that sharply
curtailed leisure activities and spending on non-
essentials.

Ryutaro Kono/ Hiroshi Shiraishi 12 May 2011

Market Mover 18 www.GlobalMarkets.bnpparibas.com
Meanwhile, aftershocks, disrupted public Chart 3: Real Exports and Imports (2005=100)
transportation and anxieties about the nuclear crisis
kept many consumers at home – to the detriment of 140

restaurants and shopping districts. 130

The disaster has been especially brutal for car sales 120

as supply constraints have limited the ability to 110

produce finished cars. Spending on storable
foodstuffs (e.g. instant noodles) and daily necessities 100

(such as toilet paper) increased on hoarding in the 90

weeks following the quake. However, consumption Exports
as a whole has dropped sharply since 11 March. 80 Imports

70
Meanwhile, private housing investment should show 07 08 09 10 11
growth of 2.2% q/q (2.9% q/q in Q4) on the back of
the recovery in housing starts that began in H2 2010.
But with housing starts in March dropping a relatively Source: BoJ, MoF, BNP Paribas
steep 7.5% m/m, the outlook for housing investment
does not look good. Chart 4: Consumption Expenditure
(real, s.a., 2005=100)
Private non-residential investment (corporate capex) 104
is likely to have turned sour with a drop of 1.3% q/q
Monthly
(+0.5% q/q in Q4). Prior to the disaster, domestic 102
Quarterly
investment was gradually starting to gain traction in
100
tandem with rising operating rates. But it is likely to
have contracted sharply after the earthquake due to 98
severe supply constraints. Indeed, capital goods
shipments in March plunged 18.1% m/m (+6.3% in 96
February). Looking from the demand side,
heightened uncertainties over the outlook probably 94

led many companies to hold back on investing.

92
08 09 10 11
As for private inventory, we expect stocks will again
weigh on GDP with a negative contribution of 0.3pp Source: MIC, BNP Paribas

(having also subtracted 0.3pp in Q4). Inventories are

expected to drop both for products in stock and
distributors’ stock, reflecting shortages linked to
diminished production capacity.
Public consumption brisk on disaster relief
spending
Public investment should decline 1.2% q/q, a modest
drop compared to the fall of 5.6% in Q4, due to the
enactment in November of an extra budget for FY
2010. With respect to both private housing
investment and public investment, the figures for Q1
will be estimated on the assumption that there was
no construction activity after the earthquake in the
three prefectures hit hardest by the disaster (Miyagi,
Iwate and Fukushima).
Meanwhile, public consumption is expected to post
relatively high growth of 0.8% q/q (0.3% in Q4),
reflecting the start of spending on disaster relief.
Greatly improved power supply situation this
summer
Looking ahead, the speed at which power generation
can be increased and supply chains restored will
determine the economy’s performance. On the
former, Tepco now expects to have more generating
capacity this summer than first anticipated. This has
allowed the government to consider easing the
power-saving target for large-lot users from 25% to
15%.
Many of these big energy consumers have already
devised plans to reduce usage this summer by 25%,
so production activities will certainly be curbed. Still,
the degree of the impact will likely be much less than
we first feared. Accordingly, it now seems more likely
that the economy will return to positive growth in Q3
2011, rather than Q4 as we previously projected.
Supply chains should be largely restored by
summer
As for supply chain problems, conditions should
improve significantly by the summer thanks to the
utmost efforts by the companies involved.
Nevertheless, a complete resolution looks to be
some way off.

Ryutaro Kono/ Hiroshi Shiraishi 12 May 2011

Market Mover 19 www.GlobalMarkets.bnpparibas.com
As alluded to above, the sector hit hardest by supply
constraints is car making. With a few exceptions,
operating levels are expected to remain low at
roughly 50% over the coming months.
Although we feel operating rates for most carmakers
could rise significantly in June-July, it will probably
take until the autumn for automobile production
returns to pre-disaster levels.
Taken as a whole, disrupted supply chains should
show significant improvement this summer but
problems are unlikely to be fully overcome until Q4
2011.
Meanwhile in Tohoku, where the outlook for power
supply is worse than in Kanto, the very restoration of
disrupted supply chains could aggravate the area’s
power deficiency by triggering increased demand.
Thus, while the economy now looks likely to return to
growth from Q3, power shortages will continue to
limit the pace of recovery for some time.
Supply constraints also adversely impact
demand
Neither should we overlook the adverse impact
supply constraints have on demand (secondary
effects). That production is being hampered on such
a wide scale, well beyond the areas directly
damaged by the disaster, means corporate earnings
are taking a big hit.
If the problem lasted only a couple of months, the
impact on corporate behaviour of supply constraints
might not be too significant. But if production is
expected to be impeded for as long as six months,
companies will likely start adjusting their spending.
By the same token, a drop in corporate earnings will
lead to reduced income for households. Even if
companies strive to not to lay off workers on the
belief that production will eventually return to normal,
reducing working hours in the meantime will
inevitably reduce average take-home pay – to the
detriment of consumption.
Although the current drop in consumption is largely
attributed to self-restraint, it could also reflect
suspicions that future income (especially bonuses)
will be impaired by the supply constraints currently
weighing on production.
Positive growth from Q3
Judging from the production plan survey for industrial
production in April (+3.9% m/m) and May
Ryutaro Kono/ Hiroshi Shiraishi
Market Mover
Chart 5: Capital Goods Shipments (s.a.,
2005=100)
120
110
100
90
80
Mothly
70
Quarterly
60
08 09 10 11
Source: METI, BNP Paribas
(+2.7% m/m), economic activity could already be
recovering. Additionally, with the outlook for power
supply this summer so much better than before, it
now seems likely that the economy will continue
strengthening.
While the degree of economic contraction in Q2 will
probably rival that of Q1 owing to the base effect
from the steep plunge posted in March, a return to
positive growth now looks likely in Q3. Even so,
growth in the coming quarters will be affected by the
secondary effects on the demand side described
above. These will partially offset the economic
benefits from reconstruction demand.
Making matters worse, it is hard to imagine national
sentiment recovering appreciably as long as
aftershocks continue and the Fukushima crisis
remains unresolved. The power shortage issue is
also likely to continue into 2012 (and beyond),
preventing reconstruction demand from translating
into robust growth.
Our provisional growth forecasts given the
improvement in the outlook for power supply over the
summer are -0.5% y/y for CY 2011 (up from -1.2%
before) and 1.9% for CY 2012 (1.6% before).
On a quarterly basis, we look for an annualised
3.0% q/q contraction in Q2, followed by 1.8% growth
in Q3 and 3.0% growth in Q4. We will review our
forecasts after the release of the preliminary Q1 GDP
report.
12 May 2011
20 www.GlobalMarkets.bnpparibas.com
Japan: Restarting Idle Nuclear Reactors
„ The government has called for Chubu
Electric’s Hamaoka nuclear reactors to be shut
down, saying it is an “exceptional case”.
„ But in the wake of the Fukushima crisis,
keeping reactors running, to say nothing of
restarting plants idled for inspection, may prove
hard.
„ Plants in Japan must undergo inspections
after being in operation for 13 straight months.
Furthermore, local communities effectively have
the last word in deciding whether these reactors
can resume operations.
„ With the shutting down of the Hamaoka
reactors, 36 of Japan’s 54 nuclear power plants
will be out of operation. If all of these units
remain inactive, the whole country will suffer
power shortages.
„ Given the likely difficulty in restarting idle
reactors, Japan could experience protracted
power shortfalls that could cause foreign
corporations to shun the country and local
manufacturers to shift production overseas.
Shutting down Hamaoka is “exceptional case”
Prime Minister Kan held an unscheduled news
conference on 6 May to announce that the
government was urging Chubu Electric to suspend all
operations at its sole nuclear power facility, located in
Omaezaki, Shizuoka. Citing predictions (by the
Education, Culture, Sports, Science and Technology
Ministry) of an 87% chance of a magnitude-8
earthquake hitting the area within 30 years, the
government wants Chubu Electric to shut down the
two active reactors at its Hamaoka plant until
adequate safety measures have been introduced
(one reactor is already down for inspections).
Like the troubled Fukushima nuclear power facilities,
Hamaoka is situated in a low-lying area close to the
Pacific Ocean. As such, safety measures now
deemed necessary include a seawall 15 metres high
to protect against tsunamis; constructing such a wall
could take years to complete.
The prime minister stressed that the high probability
of an earthquake made Hamaoka an “exceptional
case”, adding that the government does not intend to
suspend operations at any of the other reactors now
in operation. The government’s commitment to safe
Ryutaro Kono/ Makiko Fukuda
Market Mover
nuclear power was reiterated by Deputy Chief
Cabinet Secretary Sengoku on 8 May when he said
on television: “There's no particular concern about
nuclear plants on the coasts of the Sea of Japan or
the Seto Inland Sea. This can be backed up
scientifically. We're firmly behind nuclear power for
our energy strategy and policy.”
Such comments suggest that the government wants
the nation’s nuclear reactors to continue running,
with those plants that have been idled for periodic
inspections restarted. We doubt if this is feasible.
Fukushima crisis may make it hard to restart idle
plants
As indicated in earlier reports, we are worried that
energy-related issues will cloud Japan’s economic
future for longer than many expect. For one thing, the
power bottleneck affecting Kanto and Tohoku will
likely persist for the next few years owing largely to
the inability to readily secure the property rights
necessary for building new thermal power generating
plants or transfer stations (and transfer lines) to
bridge the east-west frequency divide.
The authorities, unable to quickly increase power
capacity, seem to hope that bottlenecks can be
resolved by getting people to change their lifestyles
so as to reduce electricity consumption.
Another concern is that the Fukushima crisis, which
has yet to be contained, will make it hard to restart
those nuclear reactors that are currently down for
periodic inspections. Currently, 15 reactors are offline
for inspections and another 11 were shut down after
the Great East Japan Earthquake. If all of these units
remain inactive, the whole country will suffer power
shortages.
The government insists that shutting down Hamaoka
is an exceptional case, but how easy will it actually
be to restart the idle nuclear plants?
Local community sentiment cannot be ignored
By law, nuclear power plants in Japan must undergo
inspections (lasting up to three months) after being in
operation for 13 straight months. Once the
inspections are complete, reactors can be restarted
after being declared safe by the Nuclear and
Industrial Safety Agency. In practice, however, the
final decision rests with the local authorities
(ultimately, the prefectural governor) in that nuclear
power companies must conclude safety agreements
with the local governments.
12 May 2011
21 www.GlobalMarkets.bnpparibas.com
Consequently, if plants are shut down because of
problems or accidents, resumption of operations is
only possible if approved by the local governments.
These safety agreements may not be legally binding,
with opinions on this differing. However, the element
of trust between the utility company and its
community is so important that local sentiment
cannot be ignored. As pointed out below, a number
of utilities are delaying restarting reactors that have
completed inspections owing to the difficulty in
winning local approval (since the Fukushima crisis,
opposition is widespread to restarting even reactors
with no past problems).
Making matters worse, the damage caused by the
Fukushima crisis has made the public more aware of
the burden of hosting nuclear power facilities. Under
existing laws, the central government extends
financial support to areas where nuclear plants are
located. But such benefits are not paid to every town
or community in the vicinity.
Those areas being left out are sure to feel hard done
by. Thus local politicians can be expected to drum up
support by focusing on the problems nuclear reactors
pose to their communities – making it all the harder
to restart idle plants.
No early start-up for Tepco’s idle Kashiwazaki
reactors
With the shutting down of Hamaoka reactors 4 and 5,
Ryutaro Kono/ Makiko Fukuda
Market Mover
36 of Japan’s 54 nuclear power plants will be out of
operation. Of the 36, 15 are down for periodic
inspections including 12 whose inspections began in
March. Some of these inspections will last more than
three months given the age of the reactors while the
36 also include a number of reactors whose restarts
had been scheduled only to be put on hold owing to
public opposition and safety issues.
Additionally, the Fukushima crisis has made it
impossible to bring the three remaining idle reactors
at Tepco’s Kashiwazaki power station onstream
anytime soon, owing to fierce opposition from local
rice farmers (Niigata is famous for high quality rice).
We note that all seven Kashiwazaki reactors were
shut down after the 2007 earthquake but four were
subsequently brought back on stream, including two
that will have to undergo periodic inspections from
August. Tepco’s power generating capacity will then
fall 1.9 million kilowatts.
In view of the difficulty in restarting idle reactors,
Tepco and other utilities will have to reconsider their
long-term plans for power generation that have
focused on nuclear power. Protracted power
shortages could cause Japan’s trend growth to
decline as foreign corporations shun Japan and local
manufacturers shift production overseas.
12 May 2011
22 www.GlobalMarkets.bnpparibas.com
Australia: Cutting Back
Chart 1: Underlying Cash Balance Estimates
„ Despite the impact of natural disasters the
government is still targeting a return to budget 3

surplus in 2012-13 from a c.3.5% deficit in 2

Govt Estimates

2010-11.
1

„ AUD 22bn of savings have been earmarked 0

over four years. Most of this figure reflects a
-1
variety of small measures, reducing confidence
that it can be delivered. -2 Underlying Cash Balance (% of GDP)
2010-11 Mid-
year Review
„ Spending growth will be restrained relative -3

to pre-crisis rates. But revenues explain the -4 2011-12 Budget

majority of improvement in the budget. -5

„ Tighter fiscal policy is sensible in the face of

95-96 97-98 99-00 01-02 03-04 05-06 07-08 09-10 11-12 13-14

a mining boom that has boosted the AUD, as it Source: Australian Treasury, BNP Paribas

reduces the upside to interest rates.

Table 1: Budget Summary
Estimates
Heading for surplus
The headline from the 2011-12 Budget is that the 10-11 11-12 12-13
government intends to return to surplus by 2012-13,
despite the cost of recent natural disasters, which led Underlying cash balance (AUD bn) -49.4 -22.6 3.5
to a slippage in 2010-11 (Chart 1). To achieve this it
highlights AUD 22bn in savings, equivalent to around Per cent of GDP -3.6 -1.5 0.2
1.6% of 2010 GDP. The government claims this will
be the fastest fiscal consolidation in at least 40 years. Fiscal Balance (AUD bn) -45.7 -20.3 4.0

According to the government’s forecasts, the overall Per cent of GDP -3.3 -1.4 0.3
improvement in the underlying cash balance between
2010-11 and 2012-13 will be AUD 52.9bn, or 3.8% of Forecasts
GDP. This will leave it with a surplus of AUD 3.5bn,
Real GDP (% y/y) 2¼ 4 3¾
0.2% of GDP (Table 1).

Main measures Nominal GDP (% y/y) 8 6¼ 5¾

The main savings measures publicised by the
government are:
ƒ Better targeting family payments (AUD 2bn);
ƒ Increasing the public sector efficiency dividend
(AUD 1.1bn);
ƒ Reforming car fringe benefits (AUD 954mn);
ƒ Phasing out the Dependent Spouse Tax Offset
(AUD 755mn); and
ƒ Removing access to the Low Income Tax Offset
for unearned income of minors (AUD 740mn).
It quickly becomes obvious that the main policies
announced by the government are only expected to
save AUD 5.55bn of the AUD 22bn of overall savings.
By implication the other savings must come from a
variety of small measures, which inevitably reduces
confidence in the government’s ability to deliver on
its targets.
Source: Australian Treasury, 2011-12 Budget Overview
Digging deeper
It is worth pointing out that while the emphasis is on
the budget being brought back into surplus by 2012-
13, the AUD 22bn of savings are cumulative over the
fiscal years 2011-12 to 2014-15. Savings over the
first two of these years amount to about AUD 9bn.
Moreover, half of the 2011-12 ‘savings’ is actually
increased revenue that results from the temporary
flood and cyclone reconstruction levy.
In AUD terms, despite talk of savings, spending is
still set to rise in the coming years. This is no
surprise. Rarely do governments cut spending in
cash terms. The usual trick is to rely on rising prices
and the expanding economy to reduce spending in
real terms and as a percentage of GDP. Nonetheless,

Dominic Bryant 12 May 2011

Market Mover 23 www.GlobalMarkets.bnpparibas.com
this should not detract from the fact that the
government intends to keep a tight lid on spending
growth. If it achieves what it has set out to do, growth
in real payments will decline from less than 1% in
2010-11 to about zero in 2012-13. This contrasts with
the near 4% average growth in real payments from
1998-99 to 2007-08.
While the government aims to control spending, most
of the closure in the deficit comes from the revenue
side. Of the 2.1pp of GDP reduction in the underlying
cash deficit between 2010-11 and 2011-12, 1.3pp
comes from receipts while only 0.7pp comes from
reduced payments as a percentage of GDP. The
remainder comes from reduced Future Fund
earnings. A similar pattern is expected in 2012-13
with the 1.7pp of GDP improvement in the underlying
cash balance coming from a 1.1pp increase in
receipts and a 0.6pp reduction in payments. Implicitly
cyclical factors are expected to play an important role
in bringing the underlying cash balance into surplus
through raising revenues.
Getting cyclical
Given savings of AUD 22bn, around AUD 33bn (or
over 2.5% of GDP) of the overall AUD 55.2bn
improvement in the underlying cash balance by
2014-15 is cyclical – i.e. determined by
improvements in the economy. Even assuming a
generous budget sensitivity to the cycle of 0.5 (i.e. a
1pp of GDP change in the output gap changes the
budget balance by 0.5pp of GDP), the 2.5pp of GDP
improvement in the budget balance implies growth of
5pp above potential in total over the next four years.
A lower cyclical sensitivity, such as the 0.3 implied in
the IMF’s fiscal projections for Australia, would
necessitate even stronger above-trend growth to
deliver the proposed improvement in finances.
However, the government’s real GDP forecast is for
growth of 4% in 2011-12 and 3.75% in 2012-13 and
3% thereafter. For the sum of these growth rates to
be 5pp above potential, potential growth would have
to be close to 2%, which is clearly too low and not
consistent with the government’s forecast growth rate
settling at 3.0% in 2013-15. This could imply that the
cyclical improvement in the underlying cash balance
is too optimistic. However, there is an alternative
explanation.
Since 2000, when commodity prices started to rise,
Australia has developed into an economy with high
nominal growth. This reflects its role as a commodity
Dominic Bryant
Market Mover
Chart 2: Real and Nominal GDP Growth
Source: Reuters EcoWin Pro, BNP Paribas
producer and exporter. As it did pre-crisis, recently
nominal growth (8.8% y/y in Q4 2010) has
significantly outstripped real growth (2.7% y/y,
Chart 2). The government expects this differential to
narrow as nominal growth slows while real growth
picks up. But it still sees nominal growth of 6.25% in
2011-2012, 5.75% in 2012-13 and 5.25% thereafter.
Such growth could justify the government’s
expectation for higher revenue in the future.
Helpful move
It is difficult to argue that fiscal policy isn’t being
tightened when a deficit of around 3.5% turns into a
surplus within two years. The high nominal growth
rate of the Australian economy means the scale of
tightening is probably not as great as such an
improvement would imply for other developed
economies with lower nominal growth. Nonetheless,
the fact that there is some tightening is helpful for the
RBA.
The RBA faces a quandary. The mining boom is in
full swing and beginning to run into capacity
constraints. The RBA’s concern is that this will
ultimately lead to higher generalised inflation at the
consumer level and has therefore adopted a bias to
hike if the economy turns out as it expects. However,
outside of mining, other sectors, particularly those
exposed to international competition, are suffering
from the high value of the AUD and higher interest
rates that the mining boom induces. To the extent
that some fiscal tightening through spending restraint
eases the pressure for the RBA to hike rates further,
and therefore limits the upside to the AUD, it will
benefit the non-resources business sector.
12 May 2011
24 www.GlobalMarkets.bnpparibas.com
BNP Paribas Surprise Indicator
Chart 1: US Surprise Indicator – Headline Index
„ Economic data were, on average, weaker
than expected in the US during April but
stronger than expected in the eurozone and UK.
„ Inflation data were, on average, once again
stronger than expected in the eurozone and the
UK over the month.
„ Meanwhile, activity data continued to
surprise to the downside in the US and the
eurozone. In the UK, they were stronger than
expected for a second month in a row.

„ Surprise indicator model details Source: Reuters EcoWin Pro, BNP Paribas SD from mean
The BNP Paribas surprise indicator shows how, on
average, the key economic data series have surprised Chart 2: US Surprise Indicator –
relative to consensus expectations. The index is calculated Biggest Mover: Inflation
as the deviation of the actual reading for each indicator
from consensus, scaled by historical volatility. The
‘surprises’ are then averaged for the latest month. A
reading above zero implies the data have, on average,
surprised on the strong side of the consensus
expectation and vice versa.
As well as an aggregated version for each economy,
the same methodology is applied to show the trends in
surprises for the various categories of data (including
surveys, activity, the labour market, inflation and housing).
US headline
The key US economic data releases were, on
average, weaker than market expectations during Source: Reuters EcoWin Pro, BNP Paribas SD from mean
April, for a second month in a row. Upward surprises
in housing data last month were more than offset by Chart 3: US Surprise Indicator –
downward surprises in surveys, activity, inflation and One to Watch: Survey
labour data.

US inflation
The main driver of the overall downward surprise in
April was weaker than expected inflation data. This is
the first time since November 2010 that inflation data
have been weaker than market expectations. PPI,
core CPI and the PCE deflator all surprised to the
downside during April, more than offsetting the
upward surprises in core PPI and import prices.

US survey
Following consistent upward surprises between
August 2010 and February 2011, surveys surprised Source: Reuters EcoWin Pro, BNP Paribas SD from mean

to the downside during April, for a second month in a

row. This mainly reflected weaker than expected
non-manufacturing ISM, Philadelphia Fed, Chicago manufacturing ISM has offset the upward surprise in
PMI and final Michigan sentiment. Since the start of manufacturing ISM – suggesting some downside
this month, the significant downward surprise in non- risks to the index in May.

Gizem Kara 12 May 2011

Market Mover 25 www.GlobalMarkets.bnpparibas.com
Eurozone headline Chart 4: Eurozone Surprise Indicator – Headline
The key eurozone economic indicators, on average, Index
slightly surprised to the upside during April, for a
seventh consecutive month. Surveys, inflation and
labour data were, on average, stronger than market
expectations. These offset a downward surprise in
activity data.

Source: Reuters EcoWin Pro, BNP Paribas SD from mean

Chart 5: Eurozone Surprise Indicator –

Eurozone inflation Biggest Mover: Inflation
Inflation data surprised to the upside during April for
a fifth month in a row. Since last December,
eurozone inflation data have been, on average,
stronger than market expectations. Over the past
fifteen months, there has only been one downward
surprise – September 2009. In April, upward
surprises in French CPI and PPI, Italian CPI and
eurozone flash HICP were the main drivers of the
overall upward surprise.

Source: Reuters EcoWin Pro, BNP Paribas SD from mean

Eurozone surveys Chart 6: Eurozone Surprise Indicator –

One to Watch: Surveys
Market forecasters continued to underestimate the
strength in surveys, which surprised to the upside in
April for a tenth month in a row. Indeed, over the past
two years, surveys have only surprised to the
downside three times. Eurozone manufacturing PMI,
German manufacturing PMI and ZEW current
conditions and French services, manufacturing PMIs
and business confidence were all stronger than
expected.

Source: Reuters EcoWin Pro, BNP Paribas SD from mean

Gizem Kara 12 May 2011

Market Mover 26 www.GlobalMarkets.bnpparibas.com
UK headline Chart 7: UK Surprise Indicator – Headline Index
UK economic data were, on average, stronger than
market expectations in April, for a third consecutive
month. Upward surprises in activity, inflation and
housing offset the downward surprises in surveys
and labour data over the month.

Source: Reuters EcoWin Pro, BNP Paribas SD from mean

UK activity Chart 8: UK Surprise Indicator –

Biggest Mover: Activity
Following downward surprises from December 2010
through February 2011, activity data surprised to the
upside in April, for a second month in a row. The
outcome mainly reflected stronger than expected
trade balance and retail sales, which more than
offset downward surprises in industrial and
manufacturing production.

Source: Reuters EcoWin Pro, BNP Paribas SD from mean

UK inflation Chart 9: UK Surprise Indicator –

Inflation data were slightly stronger than market One to Watch: Inflation
expectations during April, for an eight consecutive
month, but the upward surprise was much smaller
than in March. Over the past twelve months, inflation
data have surprised to the downside only once. In
April, output PPI, input PPI and core output PPI all
surprised to the upside, offsetting the downward
surprises in CPI, RPI and RPIX.

Source: Reuters EcoWin Pro, BNP Paribas SD from mean

Gizem Kara 12 May 2011

Market Mover 27 www.GlobalMarkets.bnpparibas.com
US: Cheat Sheet on FHLB TAPs
Chart 1: FHLB TAPs Curve
„ Fannie and Freddie continue to shrink, and
without a Congressional reprieve (which we 5.00

consider highly unlikely) their funding needs 4.50

FHLB TAPS
Treasuries
will decline over time as their businesses are 4.00

wound down. The FHLBanks will remain, and 3.50

arguably begin to play a larger role in housing 3.00

Yield (%)
finance. Although their financing needs rise and 2.50

fall based on activity in the mortgage market, we 2.00

1.50
expect the eventual reinvigoration of mortgage
1.00
financing – whenever that occurs – will
0.50
ultimately increase their funding needs.
0.00
0 5 10 15 20 25 30
„ Investors who traditionally have deeper
Term (years)
needs for secondary market liquidity, have
Source: BNP Paribas, Bloomberg
begun to evaluate FHLB TAPs. These bullet
bonds at issuance span the curve from 1-year to Chart 2: FHLB Debt Outstanding
10-year (there are some 30s) and can grow to be
multiple billions in size due to re-openings. 1,400
Discount Notes
„ STRATEGY: TAPs are an attractive Floaters 1,200
Bullets
companion to Fannie’s and Freddie’s reference Fixed Rate Callables

Debt Outstanding ($bn)

1,000
and benchmark note programmes. They offer
reasonable amounts of liquidity for all but high- 800
volume, chunky size trading and their
600
importance and liquidity in the GSE debt market 330
359
317
is likely to increase when the mortgage market 276
404
400
425
revives. 354 339
200

0
2004 2005 2006 2007 2008 2009 2010 2011*
Structure of FHLB TAPs programme Source: FHLBanks, BNP Paribas *2011 data is to 31 March 2011

TAPs are bullet bonds of various standardised

maturities, sold via competitive electronic auctions
that are held daily by the FHLBs. New issues are
opened quarterly and grow incrementally in size
through the auction process. The FHLB describes
the initiation and utility of the TAP programme:
“The TAP Issue Program was launched on July 6,
1999 as a refinement to the FHLBank bullet bond
auction process. Rather than frequently bringing
numerous small bullet issues of similar maturities to
market, the TAP Issue Program aggregates the most
common maturities (2-, 3-, 5-, 7-, and 10-year) by
reopening them over a three-month period. As a
result, most "on-the-run" issues grow throughout the
cycle. TAP Issues generally remain open for three
TAPs are bullet bonds only issued in the US
domestic market. The standardised TAPs serve as a
complement to the much more customised FHLB
Global Debt Program, which issues bullets, callables
and floating rate notes to domestic and international
investors.
Size and scope of TAPs issuance
The FHLBanks Office of Finance keeps a list of
currently outstanding TAPs issues that can be
downloaded into Excel. That list can be found here:
http://www.fhlb-
0

months, after which they are closed and a new series
of TAP Issues is opened to replace them. If market
conditions permit, previous TAP Issues that have
rolled down the curve may be reopened as the new
cycle's "on-the-run" issue.”
of.com/ofweb_userWeb/pageBuilder/tap-issue-list-
two-106
There are currently 200 TAP issues with an
aggregate amount outstanding of USD 87bn. This
represents about 25% of the FHLBanks’ bullet debt

Mary-Beth Fisher 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
28
outstanding (shown in Chart 2). Bullet issuance over given the low trading volume in the smaller issues
time has stayed relatively stable, and we expect that the TAPs yields shown are interpolated fair values
TAPs will continue to be a large share of that from Bloomberg so the curve should not be used to
issuance. estimate actual spread levels.

About a third of the outstanding issues are rather
small in size – that is, the total amount outstanding is
not currently larger than USD 100mn.There are also
25 issues spanning the 1-month to 10-year part of
the curve that have grown to over USD 1bn in size.
The largest of these issues is an off-the-run 3-year
TAP that is USD 3.5bn in size.
Chart 1 shows the yield curve for FHLB TAPs whose
issue sizes are at least USD 100mn. It is plotted for
reference against the Treasury yield curve. Note that
Liquidity and the secondary market
As is typical with all bond issues, the TAPs that end
up being larger in size – typically USD 300mn and
over – and close to par tend to trade more actively in
the secondary market. We recommend that investors
who trade in large blocks and are not typically buy
and hold, stick to the TAP issues that have grown to
over USD 1bn in size. Those currently outstanding
are shown in Table 1, along with their average daily
trading volumes (over a 30-day lookback period, data
in thousands) from TRACE.

Table 1: FHLB TAPs Outstanding >= USD 1bn

Avg Daily 
Maturity  Yield  Amount  Trading Vol 
Security Issue Date (yrs) Last Price (BFV) Outstanding (30d, M)
FHLB 4 1/4 06/10/11 05/24/2005 0.08 100.34 0.05       1,016,150,000               1,507
FHLB 3 1/8 06/10/11 05/05/2008 0.08 100.25 0.05       1,627,900,000                  619
FHLB 5 1/4 06/10/11 05/03/2006 0.08 100.37 0.05       2,070,000,000               1,967
FHLB 5 09/09/11 03/27/2006 0.33 101.49 0.07       1,132,800,000                  613
FHLB 3 3/4 09/09/11 08/05/2008 0.33 101.18 0.07       2,654,900,000               2,664
FHLB 5 5/8 11/15/11 12/04/2001 0.51 102.76 0.12       1,128,420,000                  388
FHLB 1 1/8 03/09/12 02/01/2010 0.82 100.74 0.21       1,722,500,000               4,809
FHLB 1 3/8 06/08/12 01/07/2010 1.07 101.20 0.29       2,471,815,000               7,643
FHLB 2 09/14/12 08/06/2009 1.34 102.27 0.40       2,740,800,000               5,214
FHLB 1 3/4 12/14/12 11/04/2009 1.59 102.05 0.51       3,574,700,000               5,845
FHLB 1 3/4 03/08/13 02/03/2010 1.82 102.05 0.61       1,730,650,000               7,183
FHLB 4 1/4 06/14/13 06/02/2008 2.09 107.28 0.72       1,059,700,000                  183
FHLB 5 3/8 06/14/13 05/08/2006 2.09 109.42 0.72       1,119,550,000                  883
FHLB 1 5/8 06/14/13 05/07/2010 2.09 101.94 0.73       1,568,700,000               4,347
FHLB 3 1/8 12/13/13 12/04/2008 2.59 105.44 0.94       3,355,600,000               6,625
FHLB 2 3/8 03/14/14 01/07/2010 2.84 103.70 1.05       2,063,080,000            16,932
FHLB 2 1/2 06/13/14 12/17/2009 3.09 104.64 1.16       1,279,260,000               2,978
FHLB 3 1/4 09/12/14 08/12/2009 3.33 106.37 1.28       1,229,200,000               2,776
FHLB 2 3/4 12/12/14 11/04/2009 3.58 104.59 1.40       2,109,050,000            12,380
FHLB 2 3/4 03/13/15 02/03/2010 3.83 104.42 1.52       2,587,550,000            12,139
FHLB 2 7/8 06/12/15 01/13/2010 4.08 105.00 1.65       1,894,250,000                  587
FHLB 1 3/4 09/11/15 08/04/2010 4.33 99.87 1.80       1,178,050,000                  716
FHLB 3 1/8 03/11/16 03/16/2010 4.83 104.05 2.07       1,187,450,000            17,643
FHLB 4 1/8 03/13/20 03/16/2010 8.84 105.40 3.11       1,290,840,000               2,418
Source: BNP Paribas, Bloomberg

Mary-Beth Fisher 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
29
US: Rich Cheap Points on the Curve
Chart 1: Contribution of Balance Sheet
„ Yields have ground even lower since the Expansion to Equities
beginning of last week but have been more
volatile on an intra-day basis on the back of the 1600 2.9
news originating out of eurozone and oil SPX Index
futures trading. Fed's Balance Sheet (RHS) 2.7
1400
„ While many think Treasury valuations are 2.5

stretched at these levels, the pain trade of 1200

$Trillions
2.3
lower yields might continue for a while.
2.1
1000
„ Under these circumstances, taking a delta
call might be tricky and hence we recommend 1.9
800
relying on RV plays for now. 1.7
„ STRATEGY: Consider selling 7y cash
600 1.5
versus 5y and 10y cash. Also, those looking for Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11
less volatile trade should consider receiving 7y
spread versus 5y and 10y spreads. Source: BNP Paribas

Chart 2: Equity Put Skew has Increased

Steadily Since QE2
Treasuries have been rallying since the beginning of
3.5%
last week mostly on the back of disappointing data. 3M Downside 1Y Downside
The ADP employment report and the claims data
came in below expectations which caused Treasury 3.3%
to rally. In spite of nonfarm payrolls coming out better
than expected, the unexpected worrisome news on
Greece coupled with a sell-off in commodities and 3.0%
equities helped Treasuries catch a bid. This week’s
supply also did not help pull Treasuries lower. 3y and
10y auctions came through and while there was an 2.8%
initial sell-off going into the 10y auction, news on oil
pushed Treasuries higher again.
2.5%
So even though the data has been coming in below Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11
market expectations, it hasn’t been bad enough to
account for such rich levels of Treasuries. While Source: BNP Paribas

most believe the bid in Treasuries is strongly related

Table 1: Z-Scores of Doing PCA
to bad data, we think there are other reasons to
consider. # of PCs used
1 2 3
One reason for concern is risky assets after 2Y -1.37 -1.04 -1.08
completion of QE2. Chart 1 shows how QE has 3Y -1.04 -0.32 0.68
supported equities, and as the end of QE nears, put Expiries
5Y -0.19 1.38 1.17
skews in equities have increased as well. A quick 7Y -0.47 -0.15 -1.71
look at Chart 2 shows how the downside concern has 10Y 1.11 0.53 0.08
increased steadily since November 2010. 30Y 0.84 -0.67 0.22

Source: BNP Paribas

Under these circumstances, while taking a delta call
may be tricky, opportunities still exist in the RV
space. Performing a PCA on the constant maturity
treasury (CMT) curve gives us the first clue.

Table 1 shows that after adjusting the levels of rates,

steepness and curvature of the CMT curve, we find

Rohit Garg 12 May 2011

Market Mover, Non-Objective Research Section 30 www.GlobalMarkets.bnpparibas.com
the 2y and 7y point to be rich while 5y, 10y and 30y Chart 4: 5-7-10 Tsy Fly is Too Low
are cheap.
16
Chart 4 shows the richness of the 7y point in 5-7-10
CMT fly. Alternatively, this richness can also been 12
seen in swap spreads. Chart 5 shows how the 7y
spread has been wide relative to the 5y and 10y
spreads. This is primarily due to the cash fly being 8
rich.
4
While any version of the trade can be used to fade
the richness of the 7y point, we prefer the spread
0
version since the cash fly will be more volatile than
the spread fly. As a side note, the correlation
between the spread fly and the cash fly is about -4
80%, endorsing the claim that receiving 7y spread Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11
versus 5y and 10y spread is really selling 7y Tsy vs Source: BNP Paribas
5y and 10y Tsy.
Chart 5: 5-7-10 Spread Fly is Too High
12

-4

-8
Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11

Source: BNP Paribas

Rohit Garg 12 May 2011

Market Mover, Non-Objective Research Section 31 www.GlobalMarkets.bnpparibas.com
Rally/Sell-Off – MBS Should Outperform

„ Mortgages had been trading with much Chart 1: Empirical vs Trader Durations (as of
shorter empirical durations. However, as the 10 May)
rates rally intensified, empirical durations
caught up with trader durations, which caused 1.40 Empirical Vs Trader 4s Empirical Vs Trader 4.5s
Empirical Vs Trader 5s Empirical Vs Trader 5.5s
mortgages to outperform. 1.30
Empirical Vs Trader 6s
1.20
„ We expect mortgages to outperform in both
1.10
a rally and sell-off. In a rally, mortgages should
1.00
do well due to lower volatility, benign
0.90
prepayments and the need for yield, while in a
0.80
sell-off reduced supply and benign extension
risk should cause them to outperform. 0.70

0.60
„ We have seen investor demand for loan 0.50
balance pools for call protection. For non-rolling 0.40
investors, we recommend Geo pools as an 1-Feb 3-Mar 2-Apr 2-May

alternative to HLBs as they have a somewhat

similar prepayment profile.
Source: BNP Paribas, Yield Book

Chart 2: Refi Index vs Mortgage Rates

Mortgages had been trading with much shorter 5500
empirical durations but as the rates rally intensified, 5000
the empirical durations caught up with trader
duration, which caused mortgages to outperform. In 4500

Chart 1, we show the history of the 20-day empirical 4000

versus trader hedge ratios versus 10y swap for the 3500
entire 30y coupon stack. The need for yield at current 3000
rate levels, attractive carry due to the benign
prepayment outlook, declining volatility, and less 2500

supply are all reasons why mortgages have Latest point 2000

performed well. 1500

5.2 5 4.8 4.6 4.4 4.2 4
Our benign prepayment outlook is based on
continued weakness in the housing sector, credit fee Source: Bloomberg
increases across GN, FN, and FRE, improved
delinquencies, tighter underwriting standards, and Chart 3: One-Week Performance vs Swaps by
burnout. Both existing and new home sales continue Coupon for FN 30y (as of 11 May)
to remain at the low end of their historical range, so 9
issuance and turnover speeds should continue to be 8
low. The credit fee increase will also dampen
Performance vs Swaps (in ticks)

7
issuance. 30, 60, and 90-day delinquencies across 6

FRE, FN, and GNMA have seen significant declines 5

with the declines greater than implied by seasonals. 4

Mortgage primary rates are at the lows for the year 2

and while the Refinancing index has increased by 1

around 16% over the past two weeks, the absolute 0

3.5 4 4.5 5 5.5 6 6.5
level remains depressed at less than 2300. Chart 2 is Coupon

a scatter plot of the refi index versus mortgage

primary rate, implying that rates need to rally by
Source: BNP Paribas, Yield Book
another 25bp to see the index rise above 4000. Due
to credit fee increases and burnout, a greater rally
might be needed to reach that level. In a sell-off the
additional extension fears should be mitigated as the

Timi Ajibola/ Anish Lohokare 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
32
index is already at the lows and further declines Chart 4: Ratio of States and HLBs vs Aggregate
should be muted. Speeds for FN 30y (using Mar prepays)
1m 4.0 4.5 5.0 5.5 6.0 6.5
Volatility has held its decline into the past month’s CA 94% 111% 104% 105% 109% 120%
rate rally, which bodes well for carry in mortgages NY 69% 86% 108% 113% 115% 111%
and might be a reason why investors continue buy, FL 150% 97% 82% 78% 85% 96%
TX 122% 100% 87% 88% 82% 79%
especially investors who expect volatility to decline HLB 81% 73% 70% 78% 83% 89%
further. 3m 4 4.5 5 5.5 6 6.5
CA 100% 115% 99% 100% 102% 109%
We remain overweight mortgages with an up-in- NY 85% 91% 107% 111% 111% 107%
FL 100% 75% 76% 78% 88% 100%
coupon bias. UIC underperformed as we rallied TX 102% 80% 83% 85% 82% 83%
towards 3.25% on 10y treasury and 4% current HLB 61% 57% 69% 78% 84% 95%
coupon as they were trading with much shorter 6m 4 4.5 5 5.5 6 6.5
CA 121% 132% 99% 97% 98% 105%
empirical durations compared with the rest of the NY 57% 57% 90% 103% 106% 103%
coupon stack. This might have been due to profit FL 59% 52% 67% 74% 85% 97%
taking or reaching resistance levels as their prices TX 81% 67% 83% 88% 85% 83%
HLB 44% 49% 69% 80% 86% 96%
were at all-time highs. However, once 10y Treasury
12M 4 4.5 5 5.5 6 6.5
got past 3.25%, higher coupons responded and CA 112% 131% 103% 102% 104% 102%
outperformed lower coupons during the end of last NY 55% 53% 83% 97% 103% 101%
FL 65% 54% 77% 90% 111% 100%
week (Chart 3). TX 93% 72% 84% 85% 79% 84%
HLB 73% 53% 70% 78% 81% 94%

HLB versus states Source: BNP Paribas

With the rally in rates, we have seen investors Chart 5: Ratio of States and HLBs vs Aggregate
looking for loan balance pools for call protection Speeds for Pools with Maximum Loan Size
against a further rally. While the interest in loan Greater than 150K for FN 30y (using Mar
balance pools has been tempered somewhat by the prepays)
continued specialness in dollar rolls, non-rolling
1m 4.0 4.5 5.0 5.5 6.0 6.5
accounts should consider certain GEOs versus high CA 97% 117% 108% 108% 112% 126%
loan balance pools as they offer a somewhat similar NY 72% 89% 111% 117% 120% 116%
prepayment profile with a lower pay-up. FL 156% 103% 88% 83% 91% 104%
TX 125% 106% 95% 96% 93% 88%
HLB 81% 73% 70% 78% 83% 89%
In Chart 4, we show prepayment ratios versus the 3m 4 4.5 5 5.5 6 6.5
aggregate for 1m, 3m, 6m, 12m speeds for four key CA 102% 117% 102% 103% 105% 114%
states – CA, NY, FL and TX – versus high loan NY 85% 92% 109% 114% 115% 111%
FL 100% 79% 81% 83% 94% 107%
balance pools. While one-month speeds can vary TX 105% 84% 90% 94% 91% 93%
dramatically for a variety of reasons, such as HLB 61% 57% 69% 78% 84% 95%
delinquency buyouts, HAMP, HARP etc, 3m, 6m and 6m 4 4.5 5 5.5 6 6.5
12m speeds show a trend that state prepayments are CA 122% 134% 102% 100% 102% 109%
NY 58% 58% 91% 105% 110% 107%
very similar to HLB and in some cases even better. FL 59% 54% 71% 79% 90% 104%
The analysis is based on Mar prepay speeds as TX 82% 70% 90% 97% 96% 93%
HLB 44% 49% 69% 80% 86% 96%
GEO information for FN for Apr is not yet available
but we performed the same analysis on FR based on 12M 4 4.5 5 5.5 6 6.5
CA 113% 133% 105% 105% 108% 106%
Apr prepays and saw a similar trend. NY 55% 53% 85% 100% 107% 106%
FL 65% 56% 82% 97% 119% 108%
Excluding all pools with a maximum loan size of TX 95% 75% 89% 93% 88% 94%
HLB 73% 53% 70% 78% 81% 94%
150K or smaller loan size gives similar results
(Chart 5). Overall, across coupons FL seems to be Source: BNP Paribas
the best alternative to HLBs using (using 6m ratios).
Chart 6: Pay-up and One-Month Carry in Ticks
For lower coupons, NY is also a good alternative to
for FN 30y
HLBs, while for higher coupons TX is a good
alternative. In Chart 6 we show pay-ups and one- Pay Up 1 Month Carry
month carry for 4.5s and 5.0s by state and high loan 4.5 5.0 4.5 5.0
balance. We show the computation using one-month NY 0.5 9.5 11.4 10.9
ratio but think the six-month ratio might be a more FL 0.5 9.5 11.2 11.0
useful approach as it captures both high and low TX 0.5 9.5 11.1 10.1
refinancing environments. One reason for slow HLB 7.0 14.0 11.3 11.0
speeds in Florida especially might be due to Source: eMBS, Bloomberg
continued home price deprecation, which makes it

Timi Ajibola/ Anish Lohokare 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
33
harder for borrowers to refinance given tighter somewhat improved outlook on delinquencies in
underwriting standards (Chart 7). Continued home MBS and FN, and FR continued buyout of 120+
price depreciation could also lead to higher delinquencies, a sudden jump in involuntary prepays
involuntary prepayments. However, with the is somewhat mitigated.

Chart 7: FICO, OLTV and CLTV by Coupons and States for FN 30y (pools with maximum loan size greater
than 150K)
CA FL NY TX
FICO OLTV CLTV FICO OLTV CLTV FICO OLTV CLTV FICO OLTV CLTV
4.0 768 67 67 768 68 73 765 67 66 767 68 67
4.5 759 70 69 758 71 77 757 69 67 758 71 69
5.0 736 71 72 734 73 80 734 72 64 735 74 65
5.5 725 71 76 724 74 88 723 71 63 723 77 65
6.0 716 74 86 714 77 102 713 74 68 710 81 69
6.5 707 75 79 703 79 98 702 76 63 695 82 67

Source: BNP Paribas

Timi Ajibola/ Anish Lohokare 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
34
EUR: Between Inflation and Soft Patch Risk
Chart 1: Curve and ECB Expectations
„ We explore opportunities at the long end of
the euro curve based on two distinct scenarios. 6.0 ECB -1.0
EUR 2Y Fwd
-0.5
„ From a risk perspective, chances of a “soft 5.0 EUR 2/30s (RHS inv)
patch” scenario materialising in the euro area 0.0

have recently increased. 4.0

0.5

„ STRATEGY: Investors looking for a hedge 3.0 1.0

against the contrarian “soft patch” scenario 1.5

2.0
should consider 1y-fwd 2/30s steepeners.
2.0
Consensus-driven investors, on the other hand, 1.0
should receive the 2/10/30s butterfly. 2.5

0.0 3.0
1999 2001 2003 2005 2007 2009 2011 2013

Source: BNP Paribas

Steepeners as a hedge against a further
correction in ECB policy expectations Table 1: Curve Rolldown Analysis
As with any other segment of the EUR curve, 2/30s 2/5Y 2/10Y 2/30Y 5/10Y 5/30Y 10/30Y

is quite sensitive to the absolute level of interest Spot 63 117 142 53 79 25

rates and to changes in the expected ECB policy Rolldown on Flatteners

path (Chart 1). Unsurprisingly, forward markets 1M -2 -3 -5 -1 -3 -2
accurately price sensitivity within the broad EUR 3M -5 -9 -14 -4 -9 -5
swap curve matrix. Given the current shape of the 6M -9 -16 -26 -7 -17 -9
ECB curve, a bear flattening is implied.
9M -13 -22 -36 -10 -24 -14

Controlling for the level of liquidity, both the street 12M -15 -28 -46 -12 -30 -18

and the Eonia curve are expecting Trichet to deliver 2Y -28 -48 -81 -20 -53 -34

another two rate hikes in 2011 (to 1.75%), while 3Y -38 -62 -110 -25 -72 -48

forecasts and implied OIS could diverge in 2012. Source: BNP Paribas
However, doubts about the ECB’s inflation-targeting
approach have recently emerged. Not just because Chart 2: Ex-Post and Ex-Ante Rolldown
of the ongoing high level of euro sovereign risk 1.0 3.0
EUR 2/30Y ex-ante 1Y rolldown
premia, but also due to an increased likelihood of a 2.5
EUR 2/30Y ex-post 1Y rolldown
soft patch in the UK, a persistently weak US labour 0.8
2.0
market, gyrations on FX (speculators still massively 0.6
1.5
short US dollars…) and volatile commodity markets. 0.4
1.0

0.2 0.5
We think that the EUR curve offers some interesting
opportunities for investors in search of an efficient 0.0
0.0

rates hedge against the “soft patch” scenario. For -0.2

-0.5

example, 2/30’s beta with the front end of the curve -1.0
-0.4
is among the highest on the whole curve (can vary as -1.5

we chose a different sample, though not by a large -0.6 -2.0

1999 2001 2003 2005 2007 2009 2011
amount). Hence, the 2/30s curve is likely to
outperform other segments in the event of a Source: BNP Paribas
significant revision of expectations of ECB policy.

From a carry perspective, paying 2/30s profits from

46bp on a 12-month horizon, which is the highest
rolldown among curve trades analysed in Table 1.
Note that this level of ex-ante rolldown profit is
misaligned with the amount of bear flattening implied
by forwards. The 2y rate is implied to increase by
about 50bp over the next 12 months, which in terms
of historical sensitivity, should lead to a 30bp

Patrick Jacq / Alessandro Tentori 12 May 2011

Market Mover, Non-Objective Research Section 35 www.GlobalMarkets.bnpparibas.com
flattening of the 2/30y curve. Under the assumption Chart 3: Monetary Policy and the 2/10/30s Fly
that the ex-ante rolldown profit will be realised, the
forward steepeener will generate a time value of
about 15bp more than the pure curve P&L.
Moreover, the level of ex ante rolldown is high
relative its historical range (Chart 2).

We have so far mentioned only one risk factor, i.e.

changes in ECB expectations. Another significant
source of risk for this trade comes from pension
funds’ potential answer to a “soft patch” scenario.

Theoretically, European pension funds will face lower

equity valuations and bond yields in such a scenario.
The typical investment response to a drop in liability
cover ratios should be receiving 30y rates, thus Source: BNP Paribas
leading to a flatter curve. Markets still bear in mind
the events that led the curve to a sharp inversion on Chart 4: ECB’s Timing Matters
two occasions in 2008 (June and November), but we
would note that the current market-wide level of
negative gamma risk is significantly lower than in
2008. Furthermore, Dutch cover ratios have definitely
improved over the past two years (also due to the
regulator’s effort to stabilise portfolios via recovery
plans). In a nutshell, we think the flattening risk
coming from pension funds is an important factor,
albeit not as significant as in 2007/2008.

Butterflies as a way to stick to consensus

The recent decline of the 2/10/30s fly close to the
lows of the last few years may call for some rebound
near term, in the prospect of a limited market sell-off. Source: BNP Paribas
Indeed, with little movement at the short end of the
curve, a sell-off in coming days may fuel some re-
steepening of the 2/10y segment of the curve.
Barring a sharp re-steepening at the back end of the
curve, the 2/10/30s butterfly is therefore exposed to a
temporary rebound from current levels (around 92bp
on the swap curve). Interestingly, the cost of the trade is limited and
significantly cheaper than a pure flattening trade on
However, from a medium to long-term standpoint, the the 2/10y segment, which costs more than 3bp per
recent move of the fly is only the start of a trend that month. Against this backdrop, it could make sense to
will drive the fly well below current levels. The think about receiving interest on the 2/10/30y fly after
relationship between the ECB’s monetary policy and the potential near-term rebound correction.
the fly (Chart 3) leads us to expect a significant
compression of the fly along with monetary policy TRADE IDEAS
tightening. The more the ECB tightens, the more the 1) Consensus: Receive EUR 2/10/30s at 92bp,
fly has the potential to decline (Chart 4), along with first target 70bp, rolldown -8bp/year.
the flattening of the curve. The current consensus is
that there will be two more rate hikes before the year- 2) Contrarian: Pay EUR 1y-fwd 2/30s at 99bp,
end. This suggests the fly may decline at least 20bp first target 120bp, rolldown +44bp/year.
to 25bp over the next few months.

Patrick Jacq / Alessandro Tentori 12 May 2011

Market Mover, Non-Objective Research Section 36 www.GlobalMarkets.bnpparibas.com
EUR: Liquidity Needs Fall
Chart 1: Liquidity Needs Continue to Fall
„ The new reserve maintenance period started
this week with evidence of lower needs.
„ Liquidity is abundant at this stage of the
period and allows both the frontloading of
reserves and excess liquidity, favouring
receiving interest on eonias.
„ STRATEGY: Pay the ECB gap at the current
level, with a target in the 20-25bp area.

Liquidity needs continue to fall

The new reserve maintenance period started this
week and the ECB published new reserve
requirements. They stand at EUR 206.9bn, down
EUR 1.3bn from the previous period and EUR 15bn
Source: BNP Paribas
down from the peak reached in early 2009.
Autonomous factors have also been heading south Chart 2: Excess Liquidity Drives the Gap
for months, with an even larger fall from the highs. As
a result, liquidity needs continue to decline gradually.
They are roughly around EUR 375bn. On the other
hand, liquidity provided by the ECB’s open market
operations continues to decline as well. But the
decline is slower and the current level of liquidity is
well above needs. This is allowing the frontloading of
reserves as well as excess liquidity. To illustrate this
environment, ECB figures show banks held
EUR 241bn on their current accounts on the first day
of the current period (EUR 34.1bn above
requirements) while EUR 13.1bn was put on the
deposit facility for the first day of the period. With no
change in liquidity over the coming days, this means
that banks are likely to be well ahead of requirements
when starting the second week of the period. This
has already affected eonia. After rising for several
weeks, the three-week eonia rate fell sharply, well Source: BNP Paribas
below the lows of the previous reserve period,
suggesting renewed receiving interest.
period favour a gap well above its spot level
Against this backdrop, it is highly probable that the (17.5bp).
average eonia will be much lower during the current
period than during the period that ended early this Autonomous factors may rise slightly going into the
week (1.15%). The ECB gap (refi-average eonia), at end of next week, affected by government deposits in
10bp for the latest period, is therefore set to increase Italy. But this will prove temporary and we can
again. If demand at next week’s MRO tender is close reasonably expect easier liquidity conditions for this
to the amount maturing (EUR 124.8bn) the system maintenance period than for the last one. Against this
will continue to run with a significant excess of backdrop, there is room for eonias to remain
liquidity. With no upward pressures on eonia, the received at current levels. This could be a supportive
ECB gap could rise closer to the levels it reached factor for wider OIS/BOR spreads.
during the second and third reserve periods of this
year (33-35bp). Even if these high levels are not Strategy: Pay the ECB gap at the current level, with
reached, conditions at the start of the current reserve a target in the 20-25bp area.

Patrick Jacq 12 May 2011

Market Mover, Non-Objective Research Section 37 www.GlobalMarkets.bnpparibas.com
EMU Debt Monitor: CDS Analysis
Chart 1: Wider France/Netherlands CDS, tighter OAT/DSL Chart 2: Diverging Greek & Portugal/Ireland CDS basis
160 5Y CDS basis
5Y CDS and cash
180
spreads
cash expensive vs CDS
140
130

120 80

100 30

80 -20

60 -70

40 -120

20 -170
cash cheap vs CDS
-220
0
Nov-10 Nov-10 Dec-10 Jan-11 Feb-11 Feb-11 Mar-11 Apr-11 Apr-11
Nov-10 Nov-10 Dec-10 Jan-11 Feb-11 Feb-11 Mar-11 Apr-11 Apr-11
BEL/FRA BEL/FRA cash FRA/NETH FRA/NETH cash IRE GRE POR

With the exception of Dutch CDS, all AAA CDS have edged
up slightly over the past week. The most noticeable
development has been the decoupling (illustrated in Chart 1)
between the wider France/Netherlands CDS differential – a
few basis points from early January highs close to
France/Finland CDS – and tighter cash spreads. For non-
core, Spain/Italy CDS remains close to 2011 highs while
2016 BTP/Bono spread tightened back by 20bp, which looks
unsustainable, i.e. Spain CDS basis should decline very
soon. Belgium CDS is still cheap also versus cash, especially
at the short-end of the curve (2y Olo back to expensive
All charts source: BNP Paribas
levels). As far as PIG are concerned, and as Chart 2
underscores, Greek 5y CDS basis decoupled from Portugal
and Ireland with the former in clear positive territory close to
the Italy CDS basis level – a level not seen since July 2010 –
while the latter are stuck on their lows due to the 10% rise in
LCH repo haircuts, which is historically negative for CDS
basis. In terms of implied probability of default, the 2y CDS
posted a new high around 47% and the 5y around 70% with
a 40% recovery rate while Portugal and Ireland are stable
around 20% on 2y.

CDS Table & Stats

5y FIN NETH FRA AUS BEL ITA SPA POR IRE GRE

CDS 29 31 73 63 141 152 242 643 668 1334

CDS W eekly change 2 0 2 4 9 12 19 20 25 50

cash -26 -23 -13 -4 54 84 162 837 890 1298

Basis 55 54 86 68 87 68 80 -194 -222 35

Basis Box vs G y -27.5 -28.7 2.7 -15.2 4.0 -14.7 -2.9 -277.4 -305.4 -47.9

Average -31.4 -17.0 9.4 -6.1 12.9 -0.5 5.9 -59.7 -100.0 -150.4

Max -23.8 -5.2 24.7 6.8 41.8 61.7 48.8 83.3 40.3 -18.3

Min -43.2 -28.7 -4.4 -21.3 -7.1 -23.3 -20.1 -308.0 -305.4 -224.8

Z score** -0.90 2.25 1.03 1.25 0.92 1.16 0.69 1.99 2.32 -2.40

Change to 31/12/2010 CDS Cash

2y 5y 10y Current Min/Max z-score Current z-score

FIN -4 -2 -2 AUS/BEL -78 -149/-59 0.5 -59 0.6

NETH -25 -24 -25 BEL/FRA 69 52/142 -0.5 67 -0.5

FRA -30 -30 -31 FRA/NETH 42 29/51 0.5 11 -1.1

AUS -33 -33 -26 FRA/FIN 43 36/72 -1.0 13 0.4

BEL -88 -68 -64 ITA/BEL 11 -11/82 -0.4 29 -0.1

ITA -96 -84 -82 AUS/FRA -9 -16/-2 -0.6 8 0.2

SPA -129 -105 -99 SPA/IT 91 54/128 0.3 79 0.0

POR 159 144 140 POR/SPA 400 117/417 1.8 675 1.9

IRE 106 60 40 IRE/POR 25 -31/181 -1.3 53 -0.9

GRE 833 316 249 GRE/IRE 666 227/716 2.0 408 -0.8

All charts source: BNP Paribas

** z score measures the deviation from six-month rolling average CDS/cash basis of the country versus Germany, expressed in numbers of standard deviations. A
number above 1.50 means that the cash is trading historically cheap compared with its average basis level.

Eric Oynoyan / Ioannis Sokos 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
38
EMU Debt Monitor: Key RV Charts
Chart 3: Hedged 2y/5y/10y swap fly: 4bp above fair value Chart 4: Hedged Olo 2013/16/20 fly: half of the
normalisation done
35 Hedged Swap Eur Fly ( vs 1y/2y spd) 40
US QE/ Equity
indices bottom
30
Exotic desks hedging
25 OLO 16 cheap
(rec long end) 20
5y cheap
15 10

0
5
-10
-5
-20

OLO 16 expensive
-15 -30
Exotic desks hedging
5y expens ive -40
-25 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11
Jan-08 Jul-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 2013/2016/2020 OLO Fly

Despite a four-point rally in Bund futures, 5y is still trading The belly of the Olo curve is gradually normalising from the
cheaper than fair value with the swap fly 4bp too high. Similar very cheap levels reached in mid-April. However, the Olo fly
upheavals on PIIGS in December led to a swap fly more than still has 20bp to go before it gets back to fair levels. A way to
15bp richer than fair value. 15-18 is a receiving area. play that normalisation is to sell Sep 13 versus Sep 16.
Chart 5: BTP/Bono 10y/30y box: 30y BTP becoming cheap Chart 6: DSL/OAT spreads: 30y OAT too cheap
0 Bono 30y too cheap 5
DSL cheap
0
-5
-5
-10
-10
-15
-15
-20
-20
-25
-25
-30 -30

-35 -35
DSL expensive
-40 -40
Bono 30y too expensive
-45 -45
Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11
Jan-10 Mar-10 Jun-10 Sep-10 Nov-10 Feb-11 May-11
DSL /BTAN July 13 DSL July 17/OAT Oct 17
Bono/BTP 2020/2040 box DSL July 20/OAT Apr 20 DSL Jan 41/OAT Apr 41

As highlighted in last week’s desknote, the box is a leading While the France/Netherlands CDS spread widened further,
indicator of Bono/Bund spread dynamics with, over the past OAT/DSL spreads tightened over the past week with the
year, a low box heralding all periods of Bono/Bund tightening. exception of 20y to 30y maturities. In spite of the lack of 30y
The box is only 5bp from these extreme levels. DSL supply this year, such a decoupling is unsustainable.
Chart 7: Portugal 5y CDS basis & LCH haircuts Chart 8**: OAT Apr 41 ASW: normalisation achieved
300 30
Richer cash More aggressive SMP buying of Ots 0.12
vs. CDS

200 25
SMP purchases 0.1
back to zero

100 20
0.08

LCH rises OT
0 margin from 15
35 to 45% 0.06
LCH Irish haircuts rise from Mid April
level
-100 15% to 30% 10
and from 15% to 20% for OT
0.04
LCH rises OT margin
-200 5
from 25 to 35%
0.02

-300 0
May-10 Jun-10 Jul-10 Sep-10 Oct-10 Dec-10 Jan-11 Mar-11 Apr-11
0
Portugal CDS basis 2w cumulated SMP 25 30 35 40 45 50

As stressed in the previous section on CDS, Ireland and Last month, we highlighted the expensiveness of the OAT 41
Portugal CDS basis remained on their lows. Recurrent LCH ASW level in the low 30s, calling for a high 30s level. As
repo haircut is rising – last one from 45% to 55% this week – Chart 8 shows, the normalisation has taken place, implying
and the lack of SMP activity have both pushed CDS basis that short 30y OAT ASW are at profit-taking levels.
lower.
All charts source: BNP Paribas **Chart 8 represents the distribution of the OAT 30y ASW conditional on the Bund 30y ASW using OAT 30y ASW value when Bund ASW is at the current
level +/- 2 standard deviations. The continuous distribution is obtained through a non-parametric approach called kernel density (see desknote released 13 October 2010).

Eric Oynoyan / Ioannis Sokos 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
39
EMU Debt Monitor: Trade Ideas
Chart 1: 5y/10y/15y AAA ASW Flies: Massive
„ Focus on 5y/10y/15 swap and AAA flies: 10y Richening Since Late January
the 10y point is expensive.
45 5

„ Pay Eur 10y swap in the 5y/10y/15 fly 40

targeting the mid-30s. 35

0

30
„ Sell Bund Jan 21 into Bund Jan 24 or Bund 25

July 27. 20
-5

„ Sell OAT Oct 20 into Oct 23 or Apr 26. 15

-10
10

„ Buy BTP Apr-16 vs. Aug-16 and/or Aug-15. 5

0 -15
Dec-10 Jan-11 Feb-11 Mar-11 Mar-11 Apr-11 May-11 Jun-11
FRTR 10/20 ASW-FRTR 04/26 ASW+FRTR 4/16 ASW
RAGB 7/20 ASW-RAGB 7/2027 ASW RAGB 7/15 ASW

We focus on the 5y/10y/15y AAA fly, which has RFGB 04/20 ASW-RFGB 07/25 ASW+ RFGB 04/16 ASW

moved sharply since the start of the year, and on 5y

DBR 01/21 ASW-DBR 7/27 ASW+ DBR 1/16 ASW (RHS)

Source: BNP Paribas

and 30y BTPs ahead of Friday’s taps.
Chart 2: 5y/10y/15y Swap Fly and Euribor 3m (inv
5y/10y/15y swap AAA flies scale): Fly is Expensive in its Regression
As Chart 1 illustrates, there has been a massive 70 0

richening of 10y AAA paper within the 5y/10y/15y 60

ASW fly (the chart shows the OAT, Bund, ATS and 50
1

Fin ASW flies). Historically, the fly’s behaviour tracks 40

2
very closely the slope of the curve with a curve 30

flattening/steepening being consistent with 10y 20 3

outperformance/underperformance within the fly. 10

OAT and Fin ASW flies reached new lows recently, 0

4

roughly 7bp to 10bp below the previous lows reached -10

5
in early January, while the Bund fly has returned to -20

December 2010’s extremes. -30 6

Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11

From a long-term view, as Chart 2 underscores, the Residual of the regression Eur 5y/10y/15y swap fly Euribor 3mth (Inv. RHS)
fly’s behaviour is negatively correlated to the level of Source: BNP Paribas
the risk-free Euro rate here gauged through the
3-month Euribor rate, i.e. higher ECB rates are Chart 3: Distribution of Bund Jan 16/Jan 21/27 ASW
consistent with a 10y outperformance within the fly. Fly vs. 216/27 ASW Slope: 10y Bund Too Rich
Nevertheless, the residuals of a simple regression of 0.16

the 5y/10y/15y swap fly on the level of risk-free rates 0.14

(also plotted in Chart 2), are back close to 2006’s

extreme lows. This means that the swap fly, which is 0.12

currently around 24bp to 24.5bp, should be more 0.1

than 10bp higher, which supports our view on 0.08

expensive levels on the 10y AAA paper within the
5y/15y segment. 0.06

Another strong argument supporting our view on the

0.04

expensiveness of 10y AAA in the fly is provided by a 0.02

non-parametric approach we developed to analyse 0

the risk/reward of relative value trades through their -13 -8 -3 2 7

position within their conditional distribution. Charts 3
and 4 exhibit the distribution of the Bund Jan 16/Jan
21/July 27 ASW and OAT Apr 16/Oct 20/Apr 26 ASW
flies versus the ASW slope. The two flies, especially
the OAT, are trading on the far left of their
distribution, implying that 10y Bund and OATs are at
Distribution of the Bund ASW fly conditional on the 2016/2027 ASW slope
using ASW fly values when 2016/2027 ASW slope is at the current level
+/- 2 standard deviations. The continuous distribution is obtained through
a non-parametric approach called kernel density (see desknote released
13 October 2010).
Source: BNP Paribas

Eric Oynoyan / Ioannis Sokos 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
40
selling levels (the OAT is more than 10bp away from
its distribution peak). Chart 4: Distribution of OAT Apr 16/Oct 20/Apr
26 ASW Fly vs. 2016/2026 ASW Slope: 10y OAT
Trade ideas Also Too Rich
On the swap curve, we recommend paying the 10y
within the 5y/10y/15y fly around 24bp to 24.5bp, 0.12

targeting a return to the mid-30s. The three-month 0.1

profit of carry is 2bp.
0.08

On the cash curve and in terms of switches, we

recommend holders of OAT Oct 20 switch into 0.06

longer-dated maturities such as Oct 23 (21bp pick-

0.04
up) or Apr 26, which benefits from recurrent buying
interest from local insurance companies. For holders 0.02

of the 10y Bund, we highly recommend switching into

Bund 2024 with a 25bp pick-up or – for the more 0
3 8 13 18 23 28
aggressive – into Bund July 27, targeting a return to
the low 40s. Source: BNP Paribas

BTP auctions Chart 5: BTPs ASW Curve on 5y Sector

The Italian Tesoro reopens BTP Apr-16 for 110

EUR 2.5-3.5bn and Sep-40 for EUR 1-1.75bn on

Friday. Italian spreads have been affected by the 105

renewed concerns about Greece, especially potential 4-2016

100
restructuring scenarios. However, as we’ve said
many times in 2011, contagion to BTPs has waned 95
recently and BTPs outperform against Bonos when
risk aversion increases. For this reason, we think 11-2015 90

that, given the expected EU policy response to the

Greek issue, we could see a relief rally in the semi- 8-2015 8-2016 85

peripheral countries such as Italy and Spain. On top

of that, additional support to Greece could weigh 80
6-2015 8-2015 11-2015 4-2016 8-2016 2-2017 8-2017
more on core AAA countries which have a largest Source: BNP Paribas
contribution into the EFSF, and thus lead to a further
compression of semi-peripherals versus core Chart 6: 10/30s in ITA/SPA/BEL
spreads. 105
SPA BEL ITA
Starting with the 5y benchmark, BTP Apr-16 looks 95

quite cheap on the curve (Chart 5); 6-7bp cheap 85

versus the fitted curve. This is also due to the 75
expensiveness of the Aug-16 and Aug-15 which are
the richest bonds on this curve sector. BTP Apr-16 is 65

offering a 26bp yield pick-up versus Aug-15 (new 55

high) and 12bp versus Nov-15 (close to the high). 45

What is even more remarkable is the fact that Apr-16
35
is offering a 9bp yield pick-up versus the longer
dated Aug-16 bond. We like buying Apr-16 versus all 25
Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11
these neighbouring points with Aug-16 and Aug-15
offering the most attractive entry levels. Source: BNP Paribas

Moving to the 30y sector, the Italian curve is by far
the steepest one in 10/30s terms. The Sep-20
/Sep-40 spread has been stuck in a 90-95bp range
for more than a month now. In the meantime, the
10/30s in Spain has flattened from 88bp to 68bp.
Despite the fact that when the BTP/Bund spread
widens the 10/30s BTPs tend to flatten, this curve
sector was extremely stable during the renewed risk
aversion episode in April. Chart 6 shows the 10/30s
in the semi-peripherals group and one can see the
dislocation of the Italian curve from its peer group.
This could favour demand for the 30y BTP in the
auction since the 30y yield spread over Germany is
38bp wider than the one on the 10y sector. Beyond
the pure 10/30s trade on the BTP curve, we like the
Mar-26/Aug-39 spread which is too steep even when
taking into account the extreme steepness of the
10/30s BTP curve.

Eric Oynoyan / Ioannis Sokos 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
41
EMU Debt Monitor: Redemptions
EGB redemptions fall significantly in May to EUR 22bn from EUR 58bn in April as only Greece and Italy have paper that
mature in May. T-bill redemptions fall to EUR 83.5bn in May.
EGB Monthly Redemptions T-Bill Monthly Redemptions

Bonds Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2011 T-Bills Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2011
ITA 0.0 18.7 30.5 0.0 14.6 12.2 0.0 20.2 46.0 0.0 15.5 0.0 157.6 ITA 17.4 17.3 17.3 17.3 14.6 19.3 16.3 16.2 15.7 15.7 6.1 4.2 177.2
FRA 17.8 0.0 0.0 18.4 0.0 0.0 29.3 0.0 13.8 15.7 0.0 0.0 95.0 FRA 33.3 35.9 38.3 31.9 32.1 32.7 30.9 13.4 12.9 14.6 8.8 7.1 292.0
GER 23.3 0.0 15.0 19.0 0.0 15.0 24.0 0.0 16.0 17.0 0.0 18.0 147.3 GER 11.0 11.0 11.0 11.0 11.0 11.0 9.0 9.0 9.0 10.0 5.0 4.0 112.0
SPA 0.0 0.0 0.0 15.5 0.0 0.0 15.5 0.0 0.0 14.1 0.0 0.0 45.1 SPA 8.7 7.9 10.2 7.3 7.9 6.3 7.3 10.8 6.7 9.3 4.0 5.1 91.5
GRE 0.0 0.0 8.7 1.0 7.0 0.0 0.0 6.8 0.0 0.0 0.0 5.8 29.4 GRE 4.2 0.4 1.4 3.2 1.0 0.0 4.0 0.5 1.6 1.6 0.0 0.0 17.9
BEL 0.0 0.0 11.3 0.0 0.0 3.4 0.0 0.0 12.7 0.0 0.0 0.5 27.9 BEL 5.5 6.2 6.4 6.7 7.4 6.8 5.4 3.7 3.6 2.0 1.8 1.6 57.1
NET 13.9 0.0 0.0 0.0 0.0 0.0 14.1 0.0 0.0 0.0 0.0 0.0 27.9 NET 9.7 8.3 17.4 7.0 6.9 10.9 6.5 2.3 6.8 3.6 2.1 6.3 87.8
AUS 8.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 8.4 AUS 0.1 2.2 0.9 3.4 0.5 1.1 2.2 0.8 0.1 0.2 0.3 0.0 11.8
POR 0.0 0.0 0.0 4.5 0.0 5.0 0.0 0.0 0.0 0.0 0.0 0.0 9.5 POR 3.4 3.5 3.8 0.0 0.0 0.0 3.0 1.9 2.0 2.0 1.7 0.0 21.3
IRE 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4.5 0.0 4.5 IRE 2.1 1.2 1.6 1.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 6.2
FIN 0.0 5.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 5.7 FIN 3.5 2.3 2.6 1.5 2.2 0.7 0.0 0.4 0.5 0.0 0.0 0.0 13.8
Total 63 24 66 58 22 35 83 27 89 47 20 24 558 Total 98.9 96.2 110.9 90.6 83.5 88.9 84.6 59.1 58.9 59.1 29.8 28.2 888.6

EGB Monthly Redemptions T-Bill Monthly Redemptions

100 Monthly EGBs Redemptions 120 Monthly T-Bills Redemptions

90
100
80
70 80
60
50 60
40
30 40
20
20
10
0 0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

This Month’s EGB Redemptions This Month’s T-Bill Redemptions

Country Bond Maturity Issued EURs (bn) CRNCY Country T-Bill Maturity CRNCY EURs
ITALY CCTS 0 05/01/11 01/05/2011 03/05/2004 14.57 EUR FRANCE BTF 0 05/05/11 05/05/2011 EUR 7.38
GREECE GGB 5.35 05/18/11 18/05/2011 30/01/2001 6.40 EUR FINLAND RFTB 0 05/10/11 10/05/2011 EUR 1.89
GERMANY BUBILL 0 05/11/11 11/05/2011 EUR 5.00
GREECE GGB 5.35 05/31/11 31/05/2011 31/05/2001 0.42 EUR
FRANCE BTF 0 05/12/11 12/05/2011 EUR 8.08
Total: 21.39 GREECE GTB 0 05/13/11 13/05/2011 EUR 0.48
AUSTRIA RATB 0 05/16/11 16/05/2011 EUR 0.05
ITALY BOTS 0 05/16/11 16/05/2011 EUR 6.05
FINLAND RFTB 0 05/18/11 18/05/2011 USD 0.36
GERMANY BUBILL 0 05/18/11 18/05/2011 EUR 6.00
BELGIUM BGTB 0 05/19/11 19/05/2011 EUR 7.35
FRANCE BTF 0 05/19/11 19/05/2011 EUR 8.43
AUSTRIA RATB 0 05/20/11 20/05/2011 USD 0.01
GREECE GTB 0 05/20/11 20/05/2011 EUR 0.48
SPAIN SGLT 0 05/20/11 20/05/2011 EUR 7.91
AUSTRIA RATB 0 05/26/11 26/05/2011 EUR 0.01
FRANCE BTF 0 05/26/11 26/05/2011 EUR 8.25
AUSTRIA RATB 0 05/31/11 31/05/2011 EUR 0.08
AUSTRIA RATB 0 05/31/11 31/05/2011 EUR 0.30
ITALY BOTS 0 05/31/11 31/05/2011 EUR 8.50
NETHERLANDS DTB 0 05/31/11 31/05/2011 EUR 6.87
Total 83.47

All charts source: BNP Paribas

Eric Oynoyan / Ioannis Sokos 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
42
EUR Vega: Long-Tail Vol on Medium Expiries Rich!

„ Long-tail volatility on medium expiries looks Chart 1: Implied Volatility Changes (month to
expensive. date)
3M 6M 1Y 2Y 5Y 10Y 15Y 20Y 25Y 30Y
„ In our view, the recent rally does not
1M -2% 4% 12% 4% 3% 2% 2% 3% 3% 3%
challenge the medium-term bearish outlook for
fixed income. 2M -2% 2% 7% 4% 1% 1% 1% 1% 2% 2%

3M -2% 0% 4% 4% -1% 0% 0% 0% 1% 1%

„ STRATEGY: Sell a 2y30y 2.75% swaption 1Y 1% 1% 0% 1% -1% -1% -1% -1% -1% -1%

receiver. 2Y -2% -2% -2% -1% 1% 0% 0% 0% 0% 0%

5Y -2% -2% -2% -1% 0% -1% -1% -1% -1% -1%

10Y 0% 0% 0% 1% 1% -1% -1% -1% -1% -1%

As a result of recent structured flows, volatility on 12Y 1% 1% 1% 1% 1% 0% 0% 0% 0% 0%

medium expiries at the long end of the curve 15Y 1% 1% 1% 1% 0% 0% 0% 0% 0% 0%

continues to look expensive. In particular, recent 20Y 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%

issuance of CMS notes linked to 20y and 30y CMS 30Y 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%

rates has pushed long-tail volatility back to the top of Source: BNP Paribas

the trading range. Chart 2: 2y30y 2.75% Receiver: Terminal PnL

Profile for EUR 100m
Only the sovereign debt crisis could prevent rates
from being raised, as is envisaged by the ECB, given 5
0
EUR m

the outlook for a broader global recovery. -5

-10
-15
In our view, however, the structural consequences of -20
-25
the fragility in the euro periphery will be kept at bay -30
-35
for a few years to allow for the recapitalisation -40
programme of the banking system to progress -45
-50
toward medium-term consolidation goals. In -55
-60
particular, over the next two years, additional loans to -65
-70 Terminal PnL Profile for EUR 100m
Greece look more attractive than the implications of -75
debt restructuring from a cost-benefit perspective. In -80
0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 5.50
turn, we consider a sharp correction at the long end
unlikely over such a time horizon. Source: BNP Paribas

Hence, we recommend the following bearish trade, Chart 3: Evolution of the 30y Swap
which exploits expensive long-tail volatility on 7.0 30y swap
medium expiries:
6.0

Sell 2y30y 2.75% swaption receiver for around

5.0
250 cents (indicative)
For EUR 100mn notional, positive roll-down on the 4.0

curve and volatility surface translates to carry profit in

3.0
1 year in excess of EUR 1mn. The trade expires at a
loss if the 30y swap settles below 2.62% (Chart 2). 2.0
Note that the 30y swap has never traded at such a
level in the past 10+ years. 1.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Risks for EUR 100mn notional are as follows: Source: BNP Paribas
outright (multiplicative) vega is EUR -560k, SABR
alpha is EUR -29k; the short delta position on the 30y
is EUR -36k.

Matteo Regesta 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
43
JGBs: Focus on Political Developments
„ While JGBs will remain firm in the near
term, beware of political developments.
„ There is a risk that fiscal reform will be
postponed, in which case the fiscal premium
should rise.
„ Moreover, with the economy stalling,
economic policy delays would create further
disruptions. Populist policies and shocks in
the financial markets would be an unexpected
blow to the JGB market.
Beware of politics and policies
The JGB market is likely to remain firm in the near
term for several reasons. Global economic growth is
slowing and expectations of higher rates are
receding in the US. Moreover, the Japanese
economy is stalling, with data in coming months likely
to be even bleaker than recent announcements.
However, the 10-year JGB yield has fallen to the key
level of 1.15%. While the market could break through
it temporarily, we also need to note factors that could
spark a retreat.
There is little chance that the economy will surprise
on the upside. Rather, we should beware of politics
and policies. In particular, fiscal policies in Japan, the
US and Europe are nearing critical junctures. In
Japan, where the Kan government is in a stalemate,
investors will focus on the funding of a second
supplementary budget. In the US, federal debt is
nearing its legal limit as the battle over fiscal
reconstruction between Democrats and Republicans
intensifies. Meanwhile, debate over expanding the
EFSF in Europe is nearing a critical juncture as fiscal
worries in Greece and Portugal intensify.
Political developments could push up the fiscal
premium…
Investors will keep an eye on political developments,
particularly in Japan. The first supplementary budget
for FY2011 was passed on 2 May. Criticism of PM
Kan within the DPJ is likely to increase now, and Kan
could be forced to step down early if the LDP does
not co-operate in passing a second supplementary
budget. The LDP is already considering submitting
either a censure motion against Kan in the Upper
House (where its passage is possible since
opposition parties have a majority) or a no-
confidence motion against the government in the
Lower House in anticipation of some DPJ members
defecting.
Koji Shimamoto
Market Mover, Non-Objective Research Section
44
Chart 1: Public Support for Political Parties
(%)
DPJ
40
30
26.4
20
LDP
16.0
10
New Komeito Your-party 5.2
3.8
0
2005 2006 2007 2008 2009 2010 2011
Source: BNP Paribas
The DPJ needs to seek some sort of co-operation
with opposition parties. If a coalition government –
headed by Deputy Chief Cabinet Secretary Sengoku
and supported by FM Noda and LDP president
Tanigaki – were established, it would probably follow
the current fiscal reform line. However, if the DPJ,
now the second most popular party (the LDP recently
regained the top slot in opinion polls), continues in
power with the support of the New Komeito, the
fourth-ranked party, fiscal reform would probably be
postponed. Hence, we should beware of political
developments that could push up the fiscal premium.
…and could be an unexpected blow to JGBs
Moreover, we should not overlook mounting policy
uncertainties in nations everywhere as 2012, an
important election year, approaches. The view that
Japan needs a consumption tax hike to pay for
reconstruction after the recent earthquake is already
losing momentum in the face of public opposition.
Now that the Golden Week holidays are over, the
markets will focus on bargaining efforts to create a
coalition government before the second
supplementary budget is drawn up. Once
reconstruction policy efforts pause, a general election
will come in sight. The political situation will cause
the fiscal premium to fluctuate then.
Political risk will not just be an issue for the fiscal
premium. With the economy stalling, economic policy
delays and uncertainty about TEPCO problems
would cause further disruption. Generally speaking,
economic policy moves towards populism and risks
of financial market shocks increase when an existing
government loses leadership. Although this is not our
main scenario, it would be an unexpected blow to the
JGB market.
12 May 2011
www.GlobalMarkets.bnpparibas.com
JGBs: Pay 3y/5y/10y Swap Butterfly
Chart 1: 3y/5y/10y Butterfly (bp)
„ The belly of the curve outperformed in the
recent market rally, and some flies are -35

approaching key levels. -37

-39
„ STRATEGY: Pay swap 3y/5y/10y butterfly.
-41

-43

-45

Near key levels -47

Yen interest rates have followed US Treasury yields -49

down, but market participants appear reluctant to -51

chase the 10y JGB yield below 1.1%, while the 5y -53

and 20y yields are also near psychologically -55

important levels at 0.4% and 1.9%, respectively. We Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11

may need fresh buying incentives to break these Source: BNP Paribas

levels significantly, given that the 5y yield has rarely

Chart 2: Longer History of 3y/5y/10y
fallen below 0.40% other than during the somewhat
Butterfly (bp)
exceptional cases of 2003 and October 2010.
0

Belly of the curve looks rich -10

We have been recommending paying a 3y/5y/10y -20

butterfly for some time now. As can be seen from
Chart 1, this butterfly spread has maintained a core -30

range of –50bp to –40bp since 2010 and currently -40

stands at –48.8bp. Long-term data indicate that -50

declines beyond –50bp have been observed only on
brief occasions, suggesting that there is relatively -60

little downside to this bearish position. Negative carry -70

is also quite tolerable at just 0.2bp over a six-month -80

horizon. Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

Source: BNP Paribas

Table 1 compares a number of bear strategies that
involve paying the body of a butterfly versus the Table 1: Comparison of Butterflies (bp)
wings in similar sectors. Estimating the upside and Carry Return Risk Ratio
Pay Body of Level 1y High 1y Low
downside in terms of maximum and minimum spread (6m) (a) (b) (=a/b)
3y / 5y / 10y -48.8 -0.2 -38.1 10.8 -51.3 -2.4 4.4 x
levels over the past year, we find that the 3s5s10s 2y1y / 3y2y / 5y2y -32.6 -0.6 -21.6 11.1 -36.0 -3.4 3.3 x
butterfly looks most attractive from a risk/reward 2y1y / 3y1y / 4y1y -8.0 0.3 -3.7 4.2 -11.1 -3.1 1.4 x
perspective. Source: BNP Paribas, As of 11 May

Those market participants who are prepared to Chart 3: 3y2y/5y5y (bp)

tolerate a somewhat higher level of downside risk 125
may wish to consider a spread position that involves 120
paying 3y2y swaps and receiving 5y5y swaps, which
is economically equivalent to the above butterfly 115

spread position. Although inferior from a risk-reward 110

perspective, this latter position in forward spreads 105

offers around 2.5bp of carry over a six-month horizon. 100

95

90

85

80
Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11

Source: BNP Paribas

Tomohisa Fujiki / Masahiro Kikuchi 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
45
Global Inflation Watch
Another strong m/m headline gain for US CPI Chart 1: US Food PPI & CPI
The US CPI is expected to increase 0.4% m/m in
April after a similar-sized gain in each of the previous
four months – on the back of further gains in gasoline
and food prices. Gasoline prices are expected to
increase by another 7.6% m/m while food prices are
forecast to increase 0.5% as rising global commodity
prices work their way through to the retail level.
Our forecast would lead the annual pace of overall
inflation to accelerate to 3.1% y/y from 2.7% in
March. This would be the fastest pace of headline
inflation since October 2008.
Excluding food and energy, we expect the CPI to rise Source: Reuters EcoWin Pro, BNP Paribas
0.2% as firms try to pass on higher input costs. Our
forecast would lead the annual pace of core inflation
to accelerate to 1.4% y/y from 1.2% in March, well up Chart 2: Easter Volatility in Package Holiday
from the record low of 0.6% reached in October Prices
2010.
Looking ahead, food and energy should continue to
drive headline inflation in the months ahead. We
don’t have inflation peaking until the summer at
around 3.6% y/y, after which it should come down
quickly as the pace of m/m energy gains slows and
base effects kick in. But core inflation should only
trend higher slowly – the weak state of the labour
market has left wage growth muted, and companies
are not in a strong position to pass on raw material
costs.
In the UK, March’s surprisingly large dip in inflation
should prove a blip on its upwards path towards a Q4 Source: Reuters EcoWin Pro, BNP Paribas
high. In April, we expect headline CPI inflation to
rebound to 4.3% from 4.0% y/y, after March’s 0.4pp
decline.
Chart 3: UK CPI & RPI
The largest contribution should come from housing
and utility inflation. April is an important month for
rents and anecdotal reports from the RICS suggest
there could be quite strong increases. This
component will also be boosted by base effects as
last April’s decline in gas prices drops out of the year-
on-year comparison.
This week’s final release for the eurozone should
confirm that inflation hit 2.8% y/y in April, its highest
level since October 2008. More important will be the
breakdown, which should reveal a significant rise in
core inflation from 1.3% to 1.6%. The late timing of
Easter means that package holiday and hotel prices
Source: Reuters EcoWin Pro, BNP Paribas
were firm at a time when they are traditionally weak.
There should be payback in May, dragging core
inflation back off its April high, but it is trending
upwards.

Luigi Speranza / Eoin O’Callaghan 12 May 2011

Global Inflation Watch 46 www.GlobalMarkets.bnpparibas.com
 Table 1: BNP Paribas' Inflation Forecasts
Eurozone France US
Headline HICP Ex-tobacco HICP Headline CPI Ex-tobacco CPI CPI Urban SA CPI Urban NSA
Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y index % m/m % y/y Index % m/m % y/y Index % m/m % y/y
2010 109.8 - 1.6 109.5 - 1.5 121.1 - 1.5 119.8 - 1.5 218.1 - 1.6 218.1 - 1.6
(1)
2011 113.0 - 2.9 112.6 - 2.8 123.8 - 2.2 122.3 - 2.1 224.8 - 3.1 224.8 - 3.1
(1)
2012 115.2 - 2.0 114.7 - 1.9 126.1 - 1.8 124.5 - 1.8 228.4 - 1.6 228.4 - 1.6

Q1 2010 108.6 - 1.1 108.3 - 1.0 120.3 - 1.3 119.0 - 1.2 217.5 - 2.4 217.0 - 2.4
Q2 2010 110.1 - 1.6 109.8 - 1.5 121.3 - 1.6 120.0 - 1.5 217.3 - 1.8 218.1 - 1.8
Q3 2010 109.9 - 1.7 109.6 - 1.7 121.2 - 1.5 119.8 - 1.5 218.0 - 1.2 218.3 - 1.2
Q4 2010 110.8 - 2.0 110.5 - 2.0 121.7 - 1.6 120.2 - 1.6 219.5 - 1.2 218.9 - 1.3
Q1 2011 111.3 - 2.5 110.9 - 2.4 122.5 - 1.8 121.0 - 1.7 222.3 - 2.2 221.7 - 2.1
(1)
Q2 2011 113.2 - 2.9 112.8 - 2.8 123.9 - 2.1 122.4 - 2.1 224.6 - 3.4 225.4 - 3.4
(1)
Q3 2011 113.3 - 3.1 112.9 - 3.0 124.1 - 2.4 122.6 - 2.3 225.6 - 3.5 225.8 - 3.5
(1)
Q4 2011 114.3 - 3.2 113.9 - 3.1 124.7 - 2.5 123.1 - 2.4 226.7 - 3.3 226.1 - 3.3

Jul 10 109.6 -0.4 1.7 109.30 -0.4 1.7 121.0 -0.3 1.7 119.68 -0.3 1.6 217.6 0.3 1.3 218.01 0.0 1.2
Aug 10 109.9 0.2 1.6 109.52 0.2 1.5 121.3 0.2 1.4 119.97 0.2 1.3 218.1 0.2 1.2 218.31 0.1 1.1
Sep 10 110.2 0.3 1.9 109.86 0.3 1.8 121.2 -0.1 1.6 119.88 -0.1 1.5 218.4 0.2 1.1 218.44 0.1 1.1
Oct 10 110.5 0.3 1.9 110.19 0.3 1.9 121.4 0.1 1.6 120.03 0.1 1.5 219.0 0.2 1.2 218.71 0.1 1.2
Nov 10 110.6 0.1 1.9 110.28 0.1 1.8 121.5 0.1 1.6 120.09 0.0 1.5 219.2 0.1 1.1 218.80 0.0 1.1
Dec 10 111.3 0.6 2.2 110.93 0.6 2.1 122.1 0.5 1.8 120.61 0.4 1.7 220.2 0.4 1.4 219.18 0.2 1.5
Jan 11 110.5 -0.7 2.3 110.11 -0.7 2.2 121.8 -0.2 1.8 120.32 -0.2 1.7 221.1 0.4 1.7 220.22 0.5 1.6
Feb 11 111.0 0.4 2.4 110.58 0.4 2.4 122.4 0.5 1.7 120.90 0.5 1.6 222.3 0.5 2.2 221.31 0.5 2.1
Mar 11 112.5 1.4 2.7 112.11 1.4 2.6 123.4 0.8 2.0 121.90 0.8 1.9 223.5 0.5 2.7 223.47 1.0 2.7
(1)
Apr 11 113.1 0.5 2.8 112.72 0.5 2.8 123.8 0.3 2.1 122.32 0.3 2.0 224.5 0.4 3.1 224.85 0.6 3.1
(1)
May 11 113.2 0.1 2.8 112.79 0.1 2.7 123.9 0.1 2.1 122.44 0.1 2.0 224.7 0.1 3.4 225.59 0.3 3.4
(1)
Jun 11 113.4 0.2 3.0 112.99 0.2 2.9 124.0 0.1 2.2 122.59 0.1 2.1 224.6 0.0 3.6 225.76 0.1 3.6
(1)
Jul 11 112.9 -0.4 3.0 112.50 -0.4 2.9 123.8 -0.2 2.3 122.35 -0.2 2.2 225.2 0.2 3.5 225.56 -0.1 3.5
(1)
Aug 11 113.2 0.3 3.1 112.83 0.3 3.0 124.2 0.4 2.4 122.79 0.4 2.4 225.5 0.1 3.4 225.74 0.1 3.4
(1)
Sep 11 113.7 0.5 3.2 113.36 0.5 3.2 124.2 0.0 2.5 122.78 0.0 2.4 226.2 0.3 3.6 226.23 0.2 3.6
(1)
Oct 11 114.1 0.3 3.2 113.67 0.3 3.2 124.4 0.2 2.5 122.91 0.1 2.4 226.6 0.2 3.5 226.30 0.0 3.5
(1)
Nov 11 114.2 0.1 3.2 113.79 0.1 3.2 124.6 0.1 2.5 123.06 0.1 2.5 226.5 0.0 3.3 226.03 -0.1 3.3
(1)
Dec 11 114.7 0.4 3.0 114.25 0.4 3.0 125.0 0.3 2.4 123.44 0.3 2.3 227.0 0.2 3.1 225.99 0.0 3.1
Updated May 12 May 12 May 05
Next
Apr HICP (May 16) May CPI (Jun 15) Apr CPI (May 13)
Release
Source: BNP Paribas, (1) Forecasts

Chart 4: Eurozone Core HICP (% y/y) Chart 5: US Core CPI (pp)

Source: Reuters EcoWin Pro Source: Reuters EcoWin Pro

Core inflation is expected to reach 1.6% in April, 0.9pp up from its Core inflation should slowly trend higher over the course of the year
February 2010 low and its highest level for two years. While we as core goods inflation rises on past commodity price surges.
expect some give back in May as Easter seasonals wash out, it Shelter inflation has bottomed but is not expected to continue to
should remain on an upward trend. rise at its current pace.

Luigi Speranza / Eoin O’Callaghan 12 May 2011

Global Inflation Watch 47 www.GlobalMarkets.bnpparibas.com
 Table 2: BNP Paribas' Inflation Forecasts
Japan UK Sweden
Core CPI SA Core CPI NSA Headline CPI RPI CPI CPIF
Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y
2010 99.3 - -1.0 99.3 - -1.0 114.5 - 3.3 223.6 - 4.6 302.5 - 1.2 194.6 - 2.0
(1)
2011 100.1 - 0.8 100.1 - 0.8 119.3 - 4.2 235.7 - 5.4 312.3 - 3.2 198.1 - 1.8
(1)
2012 100.8 - 0.7 100.8 - 0.8 122.3 - 2.3 245.0 - 4.0 319.5 - 2.3 201.0 - 1.4

Q1 2010 99.8 - -1.2 99.3 - -1.2 112.9 - 3.2 219.3 - 4.0 301.2 - 0.7 193.4 - 2.3
Q2 2010 99.3 - -1.2 99.3 - -1.2 114.4 - 3.4 223.5 - 5.1 302.8 - 0.9 194.3 - 1.9
Q3 2010 98.8 - -1.1 99.1 - -1.0 114.7 - 3.1 224.5 - 4.7 302.9 - 1.1 194.2 - 1.7
Q4 2010 99.3 - -0.5 99.4 - -0.5 115.9 - 3.4 227.0 - 4.7 307.0 - 1.9 196.4 - 2.0
Q1 2011 99.6 - -0.2 99.1 - -0.2 117.6 - 4.1 230.9 - 5.3 308.1 - 2.6 196.1 - 1.4
(1)
Q2 2011 100.1 - 0.8 100.1 - 0.8 119.2 - 4.2 235.4 - 5.3 312.0 - 3.4 197.9 - 1.8
(1)
Q3 2011 100.1 - 1.4 100.4 - 1.4 119.6 - 4.3 236.5 - 5.4 312.6 - 3.5 198.3 - 2.1
(1)
Q4 2011 100.5 - 1.2 100.6 - 1.2 120.9 - 4.3 239.8 - 5.6 316.4 - 3.4 200.2 - 1.9

Jul 10 98.8 -0.4 -1.2 99.0 -0.3 -1.1 114.3 -0.3 3.1 223.6 -0.2 4.8 302.0 -0.3 1.1 193.7 -0.3 1.7
Aug 10 98.8 0.0 -1.0 99.1 0.1 -1.0 114.9 0.5 3.1 224.5 0.4 4.7 302.1 0.0 0.9 193.7 0.0 1.5
Sep 10 98.7 -0.1 -1.1 99.1 0.0 -1.1 114.9 0.0 3.0 225.3 0.4 4.6 304.6 0.8 1.4 195.1 0.7 1.8
Oct 10 99.1 0.4 -0.6 99.5 0.4 -0.6 115.2 0.3 3.1 225.8 0.2 4.5 305.6 0.3 1.5 195.7 0.3 1.8
Nov 10 99.3 0.2 -0.5 99.4 -0.1 -0.5 115.6 0.3 3.2 226.8 0.4 4.7 306.6 0.3 1.8 196.2 0.2 1.9
Dec 10 99.5 0.2 -0.3 99.4 0.0 -0.4 116.8 1.0 3.7 228.4 0.7 4.8 308.7 0.7 2.3 197.3 0.6 2.3
Jan 11 99.5 0.0 -0.2 99.0 -0.4 -0.2 116.9 0.1 4.0 229.0 0.3 5.1 306.2 -0.5 2.5 195.2 -1.1 1.4
Feb 11 99.5 0.0 -0.3 98.9 -0.1 -0.3 117.8 0.8 4.3 231.3 1.0 5.5 308.0 0.6 2.5 196.2 0.5 1.3
Mar 11 99.7 0.2 -0.1 99.4 0.5 -0.1 118.1 0.3 4.1 232.5 0.5 5.3 310.1 0.7 2.9 196.9 0.4 1.5
(1)
Apr 11 100.0 0.3 0.7 99.9 0.5 0.7 118.9 0.7 4.1 234.9 1.0 5.4 311.4 0.4 3.3 197.6 0.4 1.8
(1)
May 11 100.1 0.1 0.8 100.1 0.2 0.8 119.3 0.3 4.3 235.7 0.3 5.4 312.2 0.2 3.4 198.0 0.2 1.8
(1)
Jun 11 100.1 0.0 0.9 100.2 0.1 0.9 119.4 0.1 4.2 235.8 0.1 5.2 312.4 0.1 3.4 198.1 0.1 1.9
(1)
Jul 11 100.1 0.0 1.3 100.3 0.1 1.3 119.1 -0.2 4.2 235.2 -0.2 5.2 311.6 -0.3 3.5 197.6 -0.2 2.0
(1)
Aug 11 100.1 0.0 1.3 100.4 0.1 1.3 119.7 0.5 4.2 236.2 0.4 5.2 312.0 0.1 3.6 198.0 0.2 2.2
(1)
Sep 11 100.2 0.1 1.5 100.6 0.2 1.5 120.1 0.3 4.5 238.0 0.8 5.6 314.3 0.8 3.5 199.3 0.7 2.1
(1)
Oct 11 100.3 0.1 1.2 100.7 0.1 1.2 120.5 0.4 4.6 238.9 0.4 5.8 315.8 0.5 3.7 199.9 0.3 2.2
(1)
Nov 11 100.5 0.2 1.2 100.6 -0.1 1.2 120.7 0.1 4.4 239.5 0.2 5.6 316.3 0.1 3.5 200.2 0.1 2.0
(1)
Dec 11 100.6 0.1 1.1 100.5 -0.1 1.1 121.5 0.6 4.0 240.9 0.6 5.5 317.0 0.2 3.0 200.5 0.2 1.6
Updated Apr 28 May 10 May 12
Next
Apr CPI (May 27) Apr CPI (May 17) May CPI (Jun 14)
Release
Source: BNP Paribas, (1) Forecasts

Chart 6: Japanese CPI (% y/y) Chart 7: UK CPI (% y/y)

Source: Reuters EcoWin Pro Source: Reuters EcoWin Pro, BNP Paribas

Core CPI inflation should turn positive again in April. We expect inflation to remain well above target for the rest of the
year.

Luigi Speranza / Eoin O’Callaghan 12 May 2011

Global Inflation Watch 48 www.GlobalMarkets.bnpparibas.com
 Table 3: BNP Paribas' Inflation Forecasts
Canada Norway Australia
CPI Core CPI Headline CPI Core CPI Core
Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y
2010 116.5 1.8 115.6 1.7 128.8 2.4 120.1 1.4 172.6 2.8 - 2.6
(1)
2011 120.0 3.0 117.3 1.5 130.7 1.5 122.0 1.6 179.3 3.7 - 2.6
(1)
2012 122.8 2.4 119.7 2.0 133.4 2.1 124.7 2.2 184.4 2.9 - 2.7

Q3 2010 116.9 2.2 1.4 116.9 0.3 1.7 128.2 -0.7 1.9 119.9 -0.3 1.2 173.3 0.7 2.8 - - 2.5
Q4 2010 117.5 2.3 1.8 117.5 2.0 1.7 129.4 0.9 2.2 120.5 0.5 1.0 174.0 0.4 2.7 - - 2.3
Q1 2011 119.4 3.3 2.0 119.4 0.7 1.6 130.2 0.6 1.4 120.3 -0.2 0.8 176.6 1.5 3.3 - - 2.3
(1)
Q2 2011 120.5 6.3 2.6 120.5 2.7 1.5 130.7 0.4 1.2 122.0 1.4 1.4 178.3 1.0 3.6 - - 2.5
(1)
Q3 2011 120.4 0.6 2.9 120.4 0.9 1.5 130.3 -0.3 1.7 122.2 0.2 1.9 179.9 0.9 3.8 - - 2.7
(1)
Q4 2011 120.9 0.9 3.0 120.9 2.7 1.5 131.7 1.1 1.8 123.4 1.0 2.4 181.0 0.6 4.0 - - 2.9
(1)
Q1 2012 122.1 2.9 3.0 122.1 1.9 1.7 132.2 0.3 1.5 123.5 0.1 2.7 182.5 0.8 3.3 - - 2.7
(1)
Q2 2012 123.1 4.4 2.7 123.1 1.9 1.8 133.5 1.0 2.1 124.8 1.0 2.3 183.6 0.6 3.0 - - 2.7
Updated May 10 May 10 Apr 26
Next
Apr CPI (May 20) May CPI (Jun 10) Q2 CPI (Jul 27)
Release
Source: BNP Paribas, (1) Forecasts

Chart 8: Canadian Total versus Core CPI Chart 9: Australian CPI (% y/y)
7.0
(% y/y)

6.0
Headline CPI
5.0
Underlying CPI
4.0

3.0

2.0

1.0

0.0

-1.0
Q193 Q195 Q197 Q199 Q101 Q103 Q105 Q107 Q109 Q111 Q113

Source: Reuters EcoWin Pro, BNP Paribas
Wage pressures appear subdued, suggesting that underlying
inflation will remain within the BoC’s target range.
Source: Reuters EcoWin Pro, BNP Paribas
Food prices should drive headline inflation sharply higher in 2011.
Underlying inflation should drift higher, but remain within the target
range. Risks to inflation are to the upside, particularly in the near
term.

CPI Data Calendar for the Coming Week

Day GMT Economy Indicator Previous BNPP F’cast Consensus
Fri 13/05 12:30 US CPI m/m : Apr 0.5% 0.4% 0.4%
12:30 CPI y/y : Apr 2.7% 3.1% 3.1%
12:30 Core CPI m/m : Apr 0.1% 0.2% 0.2%
12:30 Core CPI y/y : Apr 1.2% 1.4% 1.3%

Mon 16/05 09:00 Italy CPI (Final) m/m : Apr 0.5% (p) 0.5% 0.5%
09:00 CPI (Final) y/y : Apr 2.6% (p) 2.6% 2.6%
09:00 HICP (Final) m/m : Apr 1.1% (p) 1.1% 1.1%
09:00 HICP (Final) y/y : Apr 3.0% (p) 3.0% 3.0%
09:00 Eurozone HICP m/m : Apr 1.4% 0.5% n/a
09:00 HICP y/y : Apr 2.7% 2.8% n/a
09:00 HICP Core m/m : Apr 1.4% 0.5% n/a
09:00 HICP Core y/y : Apr 1.3% 1.6% n/a

Tue 17/05 08:30 UK CPI m/m : Apr 0.3% 0.7% 0.7%

08:30 CPI y/y : Apr 4.0% 4.3% 4.1%
08:30 RPI y/y : Apr 5.3% 5.4% 5.3%
08:30 RPIX y/y : Apr 5.4% 5.5% 5.3%

Fri 20/05 11:00 Canada CPI m/m : Apr 1.1% 0.4% 0.5%
11:00 CPI y/y : Apr 3.3% 3.4% 3.4%
Release dates and forecasts as at c.o.b. prior to the date of publication: See Daily Economic Spotlight for any revision Source: BNP Paribas

Luigi Speranza / Eoin O’Callaghan 12 May 2011

Global Inflation Watch 49 www.GlobalMarkets.bnpparibas.com
Inflation: Oil – Deleveraging at the Margin
1: Deleveraging Hits Oil – Mkt Historically Long
„ GLOBAL: Neutral BE on oil price volatility.
„ EUR: FRF outperforms. 2/10y BE still steep.
„ USD: See focus on 10y TIPS auction.
„ GBP: Keep 25/50y BE steepener into synd.

GLOBAL: Strong deleveraging in commodity

markets with a sharp increase in margin
requirements for both oil and gasoline, after the 67%
increase in silver margin requirements over the past
two weeks. US senators want the CTFC to tackle
excessive oil market speculation. Meanwhile, both
gasoline and crude inventories came in higher than Ch 2: Oil Fall Not Justified by Fundamentals (yet)
expected. WTI fell below USD 100/bbl and is now
close to February’s low. Commodities are likely to
remain volatile as deleveraging plays out. After a
15% correction in crude since the end of April, we
expect some ‘hot’ money to have been forced out,
although CTFC positioning data show the market
was historically long oil at the start of May (Chart 1).
Of some relief for bullish inflation investors, who still
have 1.5 months of positive carry to enjoy, the USD
remains weak against Asian currencies implying the
correction is not yet supported by fundamentals and
rather looks like a local liquidity issue (Chart 2).
Chart 3: Global Manufacturing PMIs – Turning?
Economic data have remained mixed to weak and
65 Chinese PMI Manu
forward-looking indicators, be they PMIs or leading US ISM Manu
economic indicators, seem to be turning even in 60 EUR PMI Manu
emerging markets and especially in the UK! (Chart UK PMI Manu
55
3). Chinese IP and last week’s PMI data were
weaker than expected, although Chinese CPI 50

inflation was higher than expected at 5.3% y/y in 45

April. Further monetary tightening (in China, at the
ECB and eventually BoE), fiscal consolidation, 40

eurozone peripheral woes and the end of the Fed’s 35

QE2 programme by the end of June does not paint a
pretty picture for H2, especially given low levels of 30
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11
real yields, and we are still likely to turn negative on
breakevens before the end of June. Despite a brief Chart 4: EUR, US & UK 2/10y Cash BE Spreads
respite early in the week, breakevens have 70 90
BOBLEI13 / BUNDEI20 Breakeven
160

unsurprisingly corrected lower again led by the front 60 80 TIIJUL12 / TIIJAN20 Breakeven Rhs
140

end resulting in a steeper inflation curve. This 50

70
120

100
provides opportunities for carry-hungry investors who 40
60 80
do not foresee further downside commodity price 30 60
50
risks. Breakeven flatteners remain the most attractive 20 40

on the very steep DBRei inflation curve, potentially in 10

40
20

US ahead of the 10y re-opening although in the UK 0

30 0

-20
the inflation curve looks flat. In Table 1, we update -10
20
UKTI13 / UKTI22 Breakeven -40
the typical oil price impact on CPI/carry in relation to -20 10
-60
the market move since the end of April. Supply and -30 0 -80

CPI data are back on the agenda in the week ahead. May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11

All Charts Source: BNP Paribas, Bloomberg

Shahid Ladha / Herve Cros 12 May 2011

Market Mover, Non-Objective Research Section 50 www.GlobalMarkets.bnpparibas.com
EUR: Massive bear steepening in European Table 1: CPI/BE Impact of Oil Collapse vs. Mkt
breakevens with the collapse in oil prices and the Oil Price Change Rule of Thumb Carry Adj BE Move
Bund future at its highs of the year. The carry Market /
Breakeven
since end April
(Domestic Ccy)
(CPI Impact of
10% move in Oil)
Domestic CPI
(/Carry) Impact
Impact on
BE (bp)
since end April
(Beta adj, 0.9)
Move -
Impact

remains supportive near term, but May/June inflation

forecasts are likely to be revised down (subject to oil USD 2y BE -19 -23 -4

price levels/volatility and pass-through to regional USD 5y BE

USD 10y BE
-13.70% 0.40% -0.55%
-10
-6
-13
-7
-4
-1
gasoline prices) which does not bode well for Q3 USD 30y BE -2 0 2

performance. Still, on a rudimentary basis, the CPI

EUR 2y BE -0.21% -5 -10 -5
impact of the oil price shock seems largely priced in EUR 5y BE +0.1% Flash -2 -3 -1
by front-end EURxt breakevens (Table 1) although EUR 10y BE
-7.16% 0.30%
surprise) -1 4 5

7y+ breakevens have not reacted enough leaving the EUR 30y BE -1 3 3

2/10s inflation spread too steep at 1/2m forwards. GBP 2y BE -4 5 9

April’s French CPI Ex-tob came in at 122.32, +0.34% GBP 5y BE

-9.13% 0.30% -0.27%
-3 -7 -4
GBP 10y BE -2 -6 -4
m/m, a little weaker than expected, but should have GBP 30y BE -1 0 1

limited impact on the final eurozone data next week

Chart 5: Strong Outperformance of 5-15y OATis
(HICPxt forecast at +0.51% m/m, 2.7% y/y next
week). This increase in the CPI is not strong enough 40
OATI19 / OATEI20 Real
25

to cause an automatic minimum wage hike. 35 OATI19 / OATEI20 Nominal Rhs

Nevertheless, such a risk exists when the May data
are released. According to our economists, a 2% 30
20
hike of the SMIC is thus possible on 1 July. The
25
French CPI data are consistent with our forecast of a
Livret A rate hike probably to 2.5% on 1 August 20
(decision after June’s CPI). The CPI data could 15
weigh slightly on OATis which have outperformed 15

strongly in the 5-15y area in recent sessions and look 10

on the rich side on a fwd basis. Given the maturity of
the bid on FRF swap and bond, this could be Livret A 5 10

related activity although some of the bid on OATis May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11

was explained by switches out of rich EURxt paper Chart 6: Contributors to Livret A Rate & Forecast
(such as 5y+ BUNDeis). On an ASW basis, OATis
6.0 %
remain attractive trading with a discount of 20bp at Forecast

10y versus close to flat on BUNDei-20 and close to 5.0 Libor

10bp on OATei-20. In the context of a potential Livret A
Rate
squeeze on liquidity (at least in commodities) and the 4.0

breakeven correction, we continue to prefer swap to

3.0
cash inflation on EURxt linkers especially versus
OBLei-18 and BUNDei-20. AFT will announce details 2.0
of the OAT(e)i auction on Friday.
1.0
Inflation
GBP: Breakevens down led by the 10y sector and
0.0
contemporary 3m lag UKTis. The concession, of up
to 5bp in BE vs. 8m lag wings, allowed a strong -1.0
GBP 1.2bn UKTi-22 auction, which had a bid/cover Feb-00 Feb-02 Feb-04 Feb-06 Feb-08 Feb-10 Feb-12

of 2.05 and premium of 10 cents (1bp). 3m lag UKTis

Chart 7: Fade 20-25y Breakevens Into UKTi-34
now look even cheaper versus 8m in our view. The
Syndication
hawkish Inflation Report (risks of CPI inflation above
5%) supported front-end breakevens, and the timing 30 240

of rate hikes remains uncertain (2bp priced by end- 260

11). Given the observed autonomy of the UK inflation 25

280
market, we could see a further outperformance vs.
USD and EUR breakevens especially with RPI 20
300

forecast to rise by +1% m/m to 5.4% next week. Real 320

yields remain very low and this is the main obstacle 15

340
for the UKTi 22-Mar-2034 syndication in the week
starting 23 May. We favour 10/50y wings to 25y BEs 10
360

ahead of the supply. Specifically, we would keep UKTI22 / UKTI37 / UKTI55 Breakeven 380
25/50y UKTi breakeven steepeners which would also UKTI22 Breakeven Rhs
5 400
benefit from further breakeven tightening and no Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11

further ultra-long linker supply in Q2.

All Charts Source: BNP Paribas, Bloomberg

Shahid Ladha / Herve Cros 12 May 2011

Market Mover, Non-Objective Research Section 51 www.GlobalMarkets.bnpparibas.com
 Table 1: BNP Paribas Carry Analysis

Benchmark Carry
Pricing Date 12-May-11 Term 1 Term 2 2m 3m 6m 12m
Repo Rate 0.42% 0.41% 0.34% 0.34% 0.34% 0.56%
Sett. Date 13-May-11 01-Jun-11 01-Jul-11 13-Jul-11 15-Aug-11 14-Nov-11 14-May-12
Yield BE Real BE Real BE Real BE Real BE Real BE Real BE
Short-end
OATei Jul-12 -1.39% 2.76% 49.2 48.7 84.4 82.4 79.6 76.6 75.2 71.9 20.1 31.5
OATI Jul-13 -0.06% 1.88% 16.5 15.2 28.9 24.9 29.7 23.9 30.4 22.1 22.4 9.7 14.4 14.4
TIPS Jul-12 -2.13% 2.38% 42.8 42.1 88.3 86.5 96.6 94.3 109.4 105.8 82.5 75.7
UKTi Aug-13 -2.17% 3.24% 35.7 34.3 41.7 37.9 42.7 37.9 35.4 28.0 51.8 37.8 90.8 70.6
5y
BUNDEI Apr-16 0.42% 1.93% 13.4 12.4 24.0 20.7 24.2 19.5 25.6 18.8 24.4 12.6 30.0 11.7
BTANI Jul-16 0.60% 2.13% 7.3 6.0 13.2 9.1 14.0 8.3 15.1 6.8 15.0 -0.4 19.8 19.8
TIPS Apr-16 -0.36% 2.08% 11.7 9.7 24.0 18.8 26.5 20.0 31.1 20.9 32.6 12.0 40.0 -3.0
UKTi Nov-17 -0.28% 3.14% 13.4 11.4 29.0 23.8 30.8 24.2 33.5 23.3 39.6 19.5 68.8 29.3
JGBI-4 June-15 0.46% -0.11% 10.7 10.3 24.5 23.6 27.5 26.5 31.4 29.9 47.3 44.0 50.5 43.3
10y
BUNDEI Apr-20 0.80% 2.18% 7.9 6.9 14.2 11.3 14.4 10.4 15.5 9.6 15.8 4.9 20.6 1.9
OATI Jul-19 0.94% 2.29% 5.0 3.8 9.3 5.6 10.0 4.9 11.0 3.6 12.0 -2.0 17.2 17.2
TIPS Jan-21 0.73% 2.42% 6.9 5.0 14.4 9.5 16.1 9.9 19.5 9.9 23.0 3.9 32.6 -6.3
UKTi Nov-22 0.49% 3.15% 10.8 9.0 20.7 16.0 21.9 16.1 24.2 15.2 29.4 11.7 49.2 14.6
JGBI-16 June-18 0.97% -0.26% 7.0 6.4 15.8 14.5 17.8 16.2 20.5 18.2 29.6 24.8 35.8 25.7
30y
OATei Jul-40 1.54% 2.49% 3.0 2.4 5.6 3.6 5.8 3.0 6.4 2.3 7.2 -0.5 10.4 -3.8
OATI Jul-29 1.51% 2.43% 2.9 2.0 5.6 2.8 6.1 2.3 7.0 1.4 8.5 -2.2 13.1 13.1
TIPS Feb-41 1.75% 2.56% 3.1 1.7 6.5 3.0 7.3 2.9 9.1 2.3 11.5 -1.7 17.2 -8.9
UKTI Mar-40 0.70% 3.51% 1.2 0.1 5.2 2.2 5.7 2.0 6.6 0.9 8.6 -2.4 16.1 -5.1
Short-end Term 1 -> Term 2 Term 1 -> Term 2 Term 2 -> 3m 3m -> 6m 6m -> 12m
OATei Jul-12 35.2 33.7 12.4 10.5 -4.4 -4.7 -55.2 -40.3 -20.1 -31.5
OATI Jul-13 12.5 9.7 6.6 3.4 0.7 -1.8 -8.0 -12.4 -8.1 4.6
TIPS Jul-12 45.5 44.4 36.4 35.2 12.8 11.5 -27.0 -30.1 -82.5 -75.7
UKTi Aug-13 6.0 3.7 6.1 3.7 -7.3 -9.9 16.4 9.8 39.0 32.8
5y
BUNDEI Apr-16 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
BTANI Jul-16 10.6 8.3 5.2 2.8 1.4 -0.7 -1.2 -6.3 5.6 -0.8
TIPS Apr-16 5.9 3.2 3.5 0.5 1.1 -1.5 -0.1 -7.2 4.8 20.2
UKTi Nov-17 12.3 9.1 9.9 6.6 4.6 0.9 1.5 -8.9 7.5 -14.9
JGBI-4 June-15 13.8 13.3 14.0 13.5 3.9 3.4 15.8 14.2 3.2 -0.7
10y
BUNDEI Apr-20 6.3 4.3 3.2 1.2 1.1 -0.8 0.3 -4.7 4.9 -3.0
OATI Jul-19 4.3 1.8 2.6 0.0 1.1 -1.3 1.0 -5.5 5.2 19.1
TIPS Jan-21 7.5 4.5 6.2 3.2 3.4 0.0 3.5 -6.1 9.6 -10.2
UKTi Nov-22 9.9 7.0 7.2 4.3 2.2 -1.0 5.2 -3.5 19.8 3.0
JGBI-16 June-18 8.8 8.1 9.0 8.2 2.8 2.1 9.0 6.6 6.2 0.9
30y
OATei Jul-40 2.6 1.2 1.4 0.0 0.6 -0.7 0.8 -2.8 3.1 -3.3
OATI Jul-29 2.6 0.8 1.8 -0.2 0.9 -0.9 1.5 -3.6 4.6 15.3
TIPS Feb-41 3.4 1.3 2.9 0.7 1.8 -0.6 2.4 -4.0 5.7 -7.2
UKTI Mar-40 3.9 2.1 2.9 1.1 0.9 -1.1 2.0 -3.3 7.5 -2.7

Source: BNP Paribas

Shahid Ladha / Herve Cros 12 May 2011

Market Mover, Non-Objective Research Section 52 www.GlobalMarkets.bnpparibas.com
US: TIPS Auction Preview, etc.
Chart 1: Dealers’ Positioning Remains Light
„ We preview the upcoming USD 11bn 10y
TIPS reopening. $bn 2.00
6 %

„ In light of ongoing high oil volatility, we 5 2.10

assess oil’s impact on breakevens. 4 2.20

„ We also provide an update on our 3

2.30
views/strategies around the TIPS auction and 2

preview April CPI. 1 2.40

0
„ STRATEGY: Stay with 5s10s BE flattener 2.50
-1
and 10s30s BE steepener into supply; still like Primary Delaer Net TIPS Position ($bn) 2.60
-2
2y1y 3y1y and 2y2y fwd BEs; long 5y5y cash BE 10y TIPS BE (%, Inverted RHS)
post supply. -3 2.70
Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11

Source: BNP Paribas

The US Treasury will auction USD 11bn of TIPS Jan- Chart 2: Retail TIPS Inflows are Improving
21 TIPS on 19 May. This reopening is similar in size
2.70 ETF Weekly Net New Assets ($mm, RHS)
to the March 10y reopening and USD 2bn below the 150
new 10y auction back in January. We don’t expect 10y BE
2.60
the dealers to bid as aggressively as they did at the
100
last 10y reopening since there is no Fed TIPS
purchase operation before the auction. Still, dealer 2.50

positioning remains relatively light (Chart 1) and the 50

Fed is likely to load up on Jan-21s the day after the 2.40

auction. Furthermore, retail demand is starting to pick

-
up (Chart 2) as breakevens continue to head lower. 2.30
Finally, non-dealer auction participation has been
relatively strong at the most recent TIPS auction, 2.20 (50)
especially considering it was a 5y auction (Chart 3).
1/13/11

1/28/11

2/11/11

2/28/11

3/14/11

3/28/11

4/11/11

4/26/11

5/10/11
Therefore, we’d expect the auction to be well
subscribed, although energy commodities and CPI Source: BNP Paribas
remain the wild cards. Stats-wise, 10y TIPS auctions
tend to produce sizeable shocks, either tailing or Chart 3: Auction Participation Relatively Strong
stopping short (Chart 4) by an average 3.4bp since 7000 $mm
the beginning of 2010. Foreign/Int'l
6000
Investment Funds
On Wednesday, it was a perfect storm of weaker 5000
China PMI, CME raising gasoline futures 4000
maintenance margins, a bearish DOE inventory
3000
report, US senators’ request to CFTC to crack down
on excessive speculation in crude oil markets, and 2000

risk aversion. This combination of factors drove oil 1000

down almost 5%, gasoline down more than 7% that 0
day and breakevens down 5-10bp, with the
10 y N o v-1 0
10 y Ja n-0 9
20 y Ja n-0 9

1 0 y Jul-0 9
2 0 y Jul-0 9

10 y Ja n-1 0

10 y Ja n-1 1
1 0 y Jul-1 0
30 y A u g-1 0
10 y A p r-0 9
5 y A p r-0 9

10 y O ct-0 9
5 y O ct-0 9

30 y F e b-1 0
10 y A p r-1 0
5 y A p r-1 0

10 y S e p-1 0
5 y O ct-1 0

30 y F e b-1 1
10 y M a r-1 1
5 y A p r-1 1

front/belly leading the drop and causing real curve to

flatten. One way to gauge the potential impact of oil
on breakevens is by using our economists’ rule of
thumb that a 10% drop in oil implies roughly a 40bp Source: BNP Paribas
impact on CPI. Thus, every USD 5 move in oil should
in theory produce around 10bp, 4bp, and 2bp impact
on 2y, 5y, and 10y BE respectively. However, using
regressions to assess oil’s impact on BEs we get
somewhat higher sensitivities. Using three months of

Sergey Bondarchuk 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
53
data, a USD 5 move in oil implies 14bp, 8.3bp, and Chart 4: 10y Auction Tail Tend to Surprise
6.3bp of moves for 2y, 5y, and 10y BEs respectively.

Strategy-wise, we stay with the 5s10s BE flattener

which has gone against us 3bp after carry over the

Tail
2.60 8
last two weeks, although a further correction in oil is %
10y Auction Tail (RHS)
6
Breakeven
a concern. The aforementioned sensitivities imply 2.40
5 6

2bp steepening for every USD 5/bbl drop in oil, but 4

2.20
around 0.25bp/day positive carry has helped absorb 2

some of the recent steepening. We also stay with the 2.00

-0.05
0.5
? 0

10s30s BE steepener into supply, which is now 5bp -2

1.80
steeper (before -2bp of negative carry) since we first -3 -4
highlighted it two weeks ago. We keep long 2y1y, 1.60 -4.5 -4.5

Stop Short
-6
3y1y and 2y2y forward cash BE recommendations
1.40 -8
but the 5s10s RY steepener is a risky proposition Jan-10 Apr-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11

now that we’ve taken off the steeper nominal call, Source: BNP Paribas
and energy commodities are still on the downward
path. We also note that 5y5y forward inflation is Chart 5: 5y5y in Cash is Starting to Look
starting to look attractive again, especially in cash Attractive, Esp. Post Supply
(Chart 5), and it looks like a potential post-supply 3.25 5y5y BE
strategy. The 5y5y cash BE carries flat. Last Value
3.00
We expect April CPI to print at 224.851, which is
2.75
slightly above consensus of 224.715. Headline
should continue to push higher with a 0.4% m/m 2.50
increase, while the core should edge up by
0.2% m/m. Gasoline (+7.6%) and food prices 2.25
(+0.5%) are expected to fuel growth in headline
2.00
again. This should send the headline number to the
fastest pace of headline inflation in almost three 1.75
years at 3.1% y/y, while core rises to 1.4% y/y. We
expect headline inflation to continue to gain, 1.50
06 07 08 09 10 11
accelerating by a further 3.6% by September, but
rapidly coming down thereafter (Chart 6). Source: BNP Paribas

Chart 6: BNPP CPI Forecast

7 30
% FORECAST
%
6
Energy yoy (RHS)
20
5
Food yoy
4
10
3
2 Core yoy Headline yoy
0
1
-10
0
-1
-20
-2
-3 -30
Dec-07 Jul-08 Dec-08 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12

Source: BNP Paribas

Sergey Bondarchuk 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
54
Technical Analysis – Interest Rates & Commodities
Bond & Short-Term Contracts
„ Europe 10y: Break below MT/ST rising channels turned it down for 2.95 but must now break below key 3.07/11
„ US 10y: A ST falling correction in “abc” is under way towards 3% but must now break below 3.15 (wave “a” low)
„ Short-term contracts u1: Up bias on ED within ST rising wedge and a ST bottoming tone on Euribor (2-lows?)

Equities & Commodities

„ WTI (Cl1): Back below key 103.39 (LT 61.8%) with risk of developing ST falling “C of ABC” below key 94.63/95.68
„ Equity markets: MT study remains positive but ST one is still slightly toppish/consolidative

US 10y: Needs to break below 3.14 (wave “A” low) to extend fall MT Trend: Up/Toppish Range: 3.10/3.30
MT SCENARIO remains up 2.88 <= 3.05 <= 3.14 –!– 3.31 => 3.37 => 3.43 => 3.50/3.53
Market remains up oriented MT within a LT
rising “C of ABC” scenario which is likely to
send it towards key 4.00/4.07 (April top & LT
61.8%) initially and perhaps then key 4.53 (LT
falling channel res). However, after a renewed
break above key 3.37 (MT 61.8%), a decisive
move above 3.49/3.53 (4-year falling res &
61.8%) is needed to strengthen this MT
bearish scenario for 3.77 last top initially.
ALTERNATIVE SCENARIO...ST correction
It could continue ST falling correction within
falling “c of abc” scenario strengthened by
move back below key 3.37 (MT 61.8%) but it
must now break below 3.14 (wave “a” low
already reached) to extend fall towards
3.00/3.05 (wave “C” target & MT 50%) and
perhaps key 2.88 (MT 61.8%).
STRATEGY
Keep long if you are below 3.23 for 3.05 now
US/EUR 10y bond: Within falling wave <C> but developing the rising wave “4” MT Trend: Down Range: 0.0/15.0
MT SCENARIO is down within wave “C” -44.6 <= -20.9 <= -7.8 <= 3.1/4.0 -!!- 13.7 => 20.3 => 27.0 => 35.7
After the 5 waves down move (major wave
“A”?) which reached 4.0/8.2 (daily & weekly
lows), it developed a correction (major wave
“B”) which ended on 44.5 (ST 50%). It is now
within the main falling wave “C” with 4.0/8.2
(daily/weekly wave “A” lows) already broken,
the next targets now being key -20.9 (LT
61.8%) and -44.6 (LT 75%).
ALTERNATIVE SCENARIO..ST rise extends
Pullback has broken above 4.0 (wave “A” low)
to extend ST recovery (a rising wave “4”)
towards 13.7 (38.2%) initially. Current break
above ST falling channel resistance (3.1)
supports this ST rising scenario. However,
17.5 wave “1” low will have to be preserved to
keep falling wave “5 of C” scenario alive.
STRATEGY
Stay long if you are above the ST falling
channel for 13-15 area

Christian Sené 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
55
Germany 10y: Positive mood towards 3% but risk of ST rising correction MT Trend: Up Range: 3.05/3.20
MT SCENARIO is still up 2.79 <= 2.96 <= 3.01 <= 3.07/11 –!– 3.23 => 3.28 => 3.34 => 3.50
The negative break above the LT falling
wedge has allowed a MT rise to develop
beyond key 3.11 (MT 61.8%) for a move
towards key 3.70 (LT 61.8%). It remains up
oriented above key 3.11 but current break
below MT rising channel support and ST one
is delaying this MT rising scenario. Needs first
to break above 3.23 (ST falling channel res).
ALTERNATIVE SCENARIO...ST correction
Top 2 bars reversal printed and break below
MT rising channel favoured a ST corrective
scenario and confirmation below ST rising
channel with a move already around key
3.07/11 (low & MT up 61.8%) and risk then
perhaps towards 2.96 (MT 38.2%).
STRATEGY
Long took some profit on 3.10 area. Keep
long if you still are for 2.95/3.00 with S/L 3.17
UK 10y: Falling “C of ABC” reached 3.34 target area MT Trend: Up/toppish Range: 3.30/3.50
MT SCENARIO remains up 2.81/2.93 <= 3.24 <= 3.38 –!– 3.45 => 3.54 => 3.61 => 3.73/75
It needs to confirm MT rising bias by
decisively overcoming critical 3.60/71/73 (LT
falling wedge res & 61.8% & MT 61.8%) to
extend rise towards 3.94 last top initially and
then 4.30 (2010 top). Note the current ST
correction (a falling ABC?) is only delaying
this scenario which would resume once this
“ABC” is over.
ALTERNATIVE SCENARIO… ST correction?
It is developing a ST falling correction within a
falling “C of ABC” scenario with 3.45 (wave
“A” low) now broken and 3.34 (wave
“C”=wave “A”) already reached, next target
being critical 3.25 (MT 61.8%).
STRATEGY
Keep long if you still are below 3.40 for 3.30

S&P: Still up within LT & MT rising channels but still risk of falling “ABC” MT Trend: Up Range: 1300/1360
MT SCENARIO is still up 1148 <= 1218/28 <= 1295 <= 1316 –!– 1380 => 1439 => 1493
The rise above the critical 1220/28 (April top &
LT 61.8%) strengthened the latest MT bullish
bias towards 1493 (LT rising channel res) and
then 1576 (2007 top). It remains up oriented
within LT rising channel (1218/1493) but now
needs to overcome 1371 last top to rekindle
latest MT rising bias.
ALTERNATIVE SCENARIO…ST correction
Rebound above 1344 top weakened the
possible end of wave “5” but a corrective
irregular “ABC” remains possible to develop a
ST falling scenario towards critical 1228/33
(key LT 61.8% & MT 38.2%) given bearish
divergences appearing on RSI. However, it
needs to break below 1316 (MT rising channel
sup) to strengthen this ST bearish scenario.
STRATEGY: Sell only below 1316, S/L 1332,
for 1230/50. Keep long within the MT channel

Christian Sené 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
56
Trade Reviews
Options, Money Market and Bond Trades – Tactical & Strategic Trades
This page summarises our main tactical (T) and strategic (S) trades. The former focus on short-term horizons (a few weeks),
allowing one to play any near-term corrections within a defined trend, while the latter rely on a medium-term assumed trend.
For each trade we provide the expected target and the recommended stop loss.

Carry P/L
Current* Targets Stop Entry Risk**
/ mth (ccy/Bp)

Closed Strategies
EUR Breakeven Flattener Buy OBLei BE 2.25% 2013 Sell BUNDei BE 1.75% . 0 40.0 12.0 20k/01 EUR
2020 (T) (31-Mar) -80k-4bp
Trade stopped due to oil price collapse (06/05). P&L: EUR -80k.

Current Strategies
Yield Curves
EUR Butterfly Receive EUR 2/5/10s M1 IMM 8.5 0.0 17.5 11.5 +1.0bp 10k/01 EUR +30k
Proxy for 2/10s flatteners with positive carry. (T) (05-Jan) +3bp

Cross Markets
DSL/OAT Spread Buy DSL 4.0% Jul-16, Sell OAT 3.25% Apr-16 2.5 9.5/10.0 1.5 4.25 . 15k/01 EUR -27k
DSL/OATs are the tightest in the 2016/2018 area. We trade a temporary widening to (T) (18-Apr) -1.75bp
9.5/10 supported by upcoming supply and RV considerations.
USD Agency Callable Long FNMA 5nc6M 2.60 Jan16 Short T 0.75 Aug13 5k 300k -150k 0k 1k/01 USD
Short-vol bullish strategies in the short end are attractive given the Fed’s position. (S) (06-Jan) 5k
Callables outperform in a range-bound environment, but currently tolerate a larger
rise in rates (+115bp) than a rally (-20bp) before breaking even over a 6m horizon.
Eurodollar/Euribor Fly Buy Eurodollar U1H2U2 Sell Euribor U1H2U2 -36 -15.0 -50.0 -40.0 . 8.75k/01 EUR 35k
RV position exploiting extreme valuation in both butterflies. (S) (09-Mar) +4bp

Options
Euribor Call Spread Buy Euribor Z1 9825/50 CS 4.5 25.0 0.0 3.25 . 12.5k/01 EUR +15k
Upside risk with good risk/reward. ECB priced at 2% year-end, could see significant (S) (12-Apr) 1.25c
retracement before then.
*Tactical (T) and strategic (S) trades. **Risk: vega, gamma for options, or ΔDV01 for futures, bonds and swaps.

Interest Rate Strategy 12 May 2011

Market Mover, Non-Objective Research Section 57 www.GlobalMarkets.bnpparibas.com
Japan: Retail Rebuilding Yen Shorts
Chart 1: TFX Net Short JPY Contracts
„ After having been stopped out on the
1,000,000
USDJPY post-quake plunge, Japanese retail TOTAL USD AUD
positioning is building yen shorts again 800,000

„ Profit-taking by these investors will slow 600,000

moves to the upside; but on the downside, the
risk is for another wash-out of positions 400,000

„ STRATEGY: Buy 1m USDJPY 25-delta risk 200,000

reversals at current levels around 0.90% in vol.
0

Jan-09

Mar-10

Jul-10

Sep-10

Nov-10

Jan-11

Mar-11
Mar-09

May-09

Sep-09

Nov-09

Jan-10
Jul-09

May-10

May-11
-200,000

Data from the Tokyo Financial Exchange (TFX) -400,000

shows that Japanese retail investors are building
substantial short yen positions again. Positions on
the TFX reached a peak of 863k contracts soon after
the 11 March quake, and BoJ Governor Shirakawa
singled out these positions as a major contributor to
the USDJPY plunge to 76.25 a week later. The
enforced liquidation of positions saw net short yen
contracts cut by 30% overnight. Post-intervention,
these were further trimmed: net shorts amounted to
just 215k contracts at the beginning of April. Those
positions are now back up to 633k contracts as of 9
May, equating to about USD 6bn of exposure.
Source: TFX, BNP Paribas
Total net short yen contracts have rebounded sharply after the enforced
liquidation as USDJPY plunged to 76.25 on 18 March; the total is back at
levels not seen before 2011. In terms of breakdown, 45% of the short JPY
positions are against USD, with another 28% against AUD; the bulk of the
rest is against EUR, GBP, NZD and ZAR.
Chart 2: USDJPY 25d Risk Reversals
0
-2
-4

-6
But the TFX represents only a small portion of the
Japanese retail market. Many prefer the convenience -8
and additional leverage provided by online trading -10
platforms – but unfortunately information from these
-12
platforms is not readily available. Extrapolating the
Jan-09

Jul-09

Jan-11
Jan-10

Jul-10
Apr-10
Oct-08

Oct-09
Apr-09

Oct-10

TFX data to the rest of the market is therefore a
necessity but involves some assumptions. The first is
that the trading directions of those investors that
trade on TFX is similar to that of online investors’; the
second assumption is that the willingness to hold
positions does not differ across platforms.
Apr-11
Source: Bloomberg
Despite sitting just above the intervention zone below 80, USDJPY risk
reversals are showing little sign of stress, trading not far from the lows at
around flat. But these levels are by historical standards unusual, even
when there is no immediate support level or extreme positioning.

Our estimates put TFX volumes at some 4-5% of

total volumes as of H1 2010. Since then, regulations
last August reduced the maximum leverage on these
platforms to 50x from an eye-popping 200x or even
400x; a further reduction limiting leverage to 20x will
take effect in August. These moves will have
somewhat reduced the relative attraction of the
online platforms, but anecdotal evidence suggests
the shift has not been significant.
Thus our estimates imply that the TFX numbers
should be scaled up by a factor of up to 20,
suggesting a total retail position somewhere north of
USD 100bn. Such a large position complicates the
MoF/BoJ approach to intervention. Should they step
in early to protect the retail position – potentially
risking moral hazard and inviting an even bigger
problem down the road? Or should they allow
another major unwind – and then step in as the pair
heads back towards 76? Certainly another unwind
would provide the justification for intervention in the
name of preventive excessive volatility. In the
opposite direction, retail accounts have consistently
been seen to be quick to take profit as and when
trades move in their favour As such, a gain in
USDJPY should see plenty of selling, slowing any
moves higher.
In this context, USDJPY risk reversals look cheap.
We suggest buying 1m 25-delta risk reversals at
current levels around 0.95% in vol.

Robert Ryan 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
58
Greek Debt Drama: FX Scenario Analysis
Chart 1: Greece Default Probabilities within Five
„ EcoFin likely to deliver the goods next week. Years
„ But ‘reprofiling’ remains a significant risk. 80%
70%
„ STRATEGY: Long EURUSD into EcoFin.
60%
50%
40%
There looks to be two realistic and two unrealistic 30%
scenarios for how the current Greece situation plays 20%
out. Below is premised on the calculation that Greece 10%
requires an additional EUR 60bn of support in 2012 0%
and 2013, assuming no access to market borrowing. Mar- Jun- Sep- Dec- Mar- Now
10 10 10 10 11
1. EU/IMF agrees to provide an additional EFSF
Source: BNP Paribas
facility for the entire amount, with Greece having
to offer up some concessions (e.g., extra collateral in Using BNP Paribas CDS prices and based on an assumed recovery rate
of 40% with an annual premium, Monday’s prices showed a 68% chance
the form of state-owned assets). Private-sector of Greece defaulting within the next five years.
agents don't bear any pain in this scenario and it is
the most EUR positive as a result. The problem may
be getting German and Finnish sign-on to such a Chart 2: EURUSD vs. 5y Risk-Adjusted Spread
plan (Finland more so than Germany).
Probability: 49%. EURUSD should push back to test 1.500
1.480 90
the recent highs in coming weeks, bringing 1.50-1.51 5Y Risk Adjusted Spread (RHS)
into play. 1.460
70
1.440
2. The EU/IMF agrees a less-than-EUR 60bn 1.420 50
package, alongside a ‘voluntary reprofiling' of 1.400 EURUSD (LHS)
existing private-sector debt. Under a ‘reprofiling’, 1.380 30
creditors agree to extend the maturity of bonds 1.360
10
scheduled to mature in 2012 and 2013. Since this 1.340
accounts for the bulk of the aforementioned 1.320 -10
EUR 60bn total, it would mean that a new EFSF 27-Jan 23-Feb 22-Mar 18-Apr 13-May
facility for Greece could be much smaller than
Source: Reuters EcoWin Pro
EUR 60bn. Banks would be expected to agree to the
plan on the basis that local Finance Ministries may Our composite US-eurozone 5y risk-adjusted spread has risen in recent
days but EURUSD has already moved down by much more than the move
offer assurances that they will be permitted to in the spread would readily justify. While we see some additional downside
continue to carry Greek (and other euro-peripheral) euro risk from a reprofiling of Greek debt that implies an extension of debt
maturities but no pay-out for holders of credit protection, other outcomes
debt on their banking books at par value. The should prove more benign/outright positive for the euro.
assumption here is that a reprofiling would not be a
‘credit event’ invoking payout under CDS contracts.
This is not necessarily going to be the case, but as
long as the reprofiling is voluntary, it creates the
necessary (if not necessarily sufficient) condition for
EU lawyers to issue an opinion that this is not a
credit event. Under this scenario, the EUR may 3. Same as 2. above but with this being
weaken, if not dramatically, on the view that such a determined to be a credit event (e.g., after a
deal doesn’t reduce the chances of an eventual successful legal challenge to a ‘no default’ ruling).
default and may be viewed as implying a lack of Probability 2%. EURUSD quickly sold down through
confidence among EU/IMF officials that Greece can 1.4000, 1.35 at risk.
prevent a future default. It would also question the
value of CDS protection across the euro-periphery, 4. Formal Greece default/debt rescheduling.
which could see non-Greek euro-peripheral bonds Further euro-periphery defaults/rescheduling
come under some pressure. anticipated.
Probability 48%. EURUSD extends recent lows but Probability 1%. EURUSD crashes down to
holds 1.40. test/break below 1.30 in the weeks ahead.

Ray Attrill 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
59
EURSEK: Lower, Barring Liquidity Stress
Chart 1: SEK Outperforms on EMU Sovereign
„ EURSEK could grind down to the lower end Stress
of an 8.75-9.05 range over several weeks as long
as GIPS sovereign risk is a dominant market
theme.
„ The tail risk of a sharp EURSEK rally could
come from a restructuring of sovereign debt
impairing bank balance sheets, in turn leading
to a funding crisis. But this is just a tail risk.
„ Sell spot on upticks and look to sell into any
strong Q2 seasonal rallies in risk reversals as
uncertainty prevails heading into June.

EURSEK should continue to move lower when Source: BBG, BNP Paribas
GIPS sovereign risk is a dominant market Chart 1 shows the 5y sovereign CDS differential (Sweden over Germany)
theme... leading EURSEK by about 30 days. This relationship has been fairly good
GIPS sovereign risk has been a key driver for since mid-2009, when the economic crisis was averted by the introduction
of extraordinary monetary and fiscal policies by several nations to deal
EURSEK: peaks have almost always coincided with with the tail risks of a potential “Great Depression 2”.
a renewed focus on Europe’s periphery, be it back on
8 April when there was renewed attention on Greece, Chart 2: But Badly Hurt When Liquidity
or the escalation of the “debt restructuring” fear on 5 Freezes
May. The main reason, we believe, is that the SEK is
rightly grouped among a pack of elite “G10 fiscal safe
havens” along with CHF and NOK. Glancing at 5y
sovereign CDS rates for the G10, Sweden comes out
second (24bp), just after Norway (18bp), and is even
ahead of stellar Switzerland (30bp). And rightly so:
Sweden’s gross debt (government budget) is about
38% GDP (-0.4%), down from 40% (-1.0%) in 2010,
with our economists forecasting an improvement to
35% (1% budget surplus) by 2012.

In comparison, the CDS for Germany, arguably the

best sovereign in the eurozone, is some 17bp higher
at close to 42bp. With talk of wealth transfers, Source: BBG, BNP Paribas

Germany’s CDS had risen to 60bp in Q4 2010. While
it has come off since then, it appears to have been
basing since April given the renewed focus on
Portuguese rescue packages and now potentially an
additional Greek package to tide over 2012/13
funding needs, and perhaps a voluntary rescheduling
of Greek debt.
Chart 2 plots the EUR 3-month LIBOR-OIS spread (an indicator of funding
stress in the inter bank market) leading the EURSEK by eight weeks. The
funding crisis sparked by the Lehman shock in Q3 2008 saw EURSEK
surge. The concern is that a sovereign debt restructuring with haircuts for
private bond investors would impair bank balance sheets, leading to a
funding squeeze and consequently a sharp EURSEK rally. However,
European officials are well aware of this tail risk and will what is required to
avert such a scenario.

Chart 1 confirms that the EURSEK should be traded

from the perspective of Sweden’s status as relative
safe haven. A grind down to the bottom of 8.75-9.05
over several months shouldn’t surprise.
… provided sovereign risk does not morph into
funding stresses…
The main risk to a bullish SEK call is if sovereign
stress morphs into liquidity tensions. See Chart 2,
plotting EURSEK against the 3m EUR LIBOR-OIS
spread, which is an indicator of banks’ willingness to
lend. EURSEK sharply rallied when the money
market seized up in 2008 after the Lehman shock.
This risk of a liquidity shock cannot be ruled out
should Greece’s woes lead to a “credit event” driven
by restructuring of debt with a haircut to private

Kiran Kowshik 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
60
investor holdings of sovereign bonds. Given that Chart 3: EURSEK Spot vs. Risk Reversals
eurozone banks have sovereign debt on their
balance sheets, this is a risk which needs to be
considered. However, our economists see this as a
tail risk, assuming that a “voluntary rescheduling
does not result in a full-blown credit event. Moreover,
the feeling is that G3 central banks, particularly the
ECB, will continue to provide liquidity to banks still
dependent on emergency funding. Recent data
showed Portuguese banks using the ECB facility to
the extent last seen in August 2010 when GIPS risks
were heightened. The consensus appears to be that
the ECB will wait until the end of the year before
returning to competitive rate tenders: a recent
Reuters poll, for instance, showed 13 out of 21 Source: BBG, BNPP
money market traders looking for unlimited three-
Chart 3 shows option risk reversals still biased to pay more for
month funds throughout Q3, with most penning the EUR calls as opposed to puts, betting that volatility will increase
same for one-month and one-week operations. on a EURSEK rally. This may seem justified especially as we
enter a typical Q2 retracement in risk assets. Recall that a
Sell EURSEK spot and seek opportunities to similar such move in Q2 2010 saw risk reversals bid up from
+1.0 to 2.50, even as spot fell 3.5% over the same period.
capitalise on any Q2 rallies in risk reversals However, spot could still continue to grind lower as it did last
Given the above risk assessment, EURSEK could year given the drivers for the move remain intact.
continue to grind lower for several months. However,
the options market appears to believe otherwise with
option risk reversals still biased to pay more for EUR Recall that Q2 2010 saw EURSEK risk reversals bid
calls as opposed to puts, betting that volatility will up from 1.0 to 2.50, even as spot fell 3.5% over the
increase on a EURSEK rally. This may seem justified same period (Chart 3). However, given that we still
and could even be accentuated as we enter a typical see a funding crisis as a tail event, a similar rally in
Q2 retracement in risk assets at a time when risk reversals in the weeks ahead could present
EURSEK options seem reasonably valued when attractive opportunities to sell into, using knock-out
comparing measures of implied versus realised 3m EUR put/SEK calls. Until then, simply selling spot
volatility. on any upticks remains appropriate.

Kiran Kowshik 12 May 2011

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
61
Economic Calendar: 13 - 20 May
GMT Local Previous Forecast Consensus
Fri 13/05 05:30 07:30 France GDP (Prel) q/q : Q1 0.4% 0.8% 0.6%
05:30 07:30 GDP (Prel) y/y : Q1 1.5% 2.0% 1.8%
06:45 08:45 Non-Farm Payrolls (Prel, sa) q/q : Q1 0.2% 0.3% 0.3%
06:45 08:45 Wages (Prel) q/q : Q1 0.3% 0.9% 0.6%
06:00 08:00 Germany GDP (Flash) q/q : Q1 0.4% 1.0% 0.9%
06:00 08:00 GDP (Flash) y/y : Q1 4.0% 4.4% 4.2%
07:30 09:30 Neths GDP (Prel) q/q : Q1 0.6% 1.0% 0.7%
07:30 09:30 GDP (Prel) y/y : Q1 2.4% 2.6% n/a
07:30 09:30 Retail Sales y/y : Mar 3.0% 2.0% n/a
07:50 09:50 Eurozone ECB’s Ordonez and Trichet Speak in Madrid
08:00 10:00 ECB’s Tumpel-Gugerell Speaks in Vienna
09:00 11:00 ECB’s Bini Smaghi Speaks in Florence
09:00 11:00 EU Issues Semi-Annual Economic Forecasts
10:00 12:00 GDP (Flash) q/q : Q1 0.3% 0.7% 0.6%
10:00 12:00 GDP (Flash) y/y : Q1 2.0% 2.3% 2.2%
16:30 18:30 ECB’s Stark Speaks in Aachen, Germany
08:00 10:00 Spain GDP (Flash) q/q : Q1 0.2% 0.2% 0.2%
08:00 10:00 GDP (Flash) y/y : Q1 0.2% 0.7% 0.7%
08:00 10:00 Italy GDP (Prel) q/q : Q1 0.1% 0.3% 0.3%
08:00 10:00 GDP (Prel) y/y : Q1 1.5% 1.3% 1.3%
08:00 10:00 Sweden Unemployment Rate : Apr 4.3% 4.1% 4.1%
12:30 08:30 US CPI m/m : Apr 0.5% 0.4% 0.4%
12:30 08:30 CPI y/y : Apr 2.7% 3.1% 3.1%
12:30 08:30 Core CPI m/m : Apr 0.1% 0.2% 0.2%
12:30 08:30 Core CPI y/y : Apr 1.2% 1.4% 1.3%
13:55 09:55 Michigan Sentiment (Prel) : May 69.8 70.0 70.0

Sun 15/05 19:45 13:45 US Fed’s Lockhart Speaks on Economic Outlook in Atlanta

Mon 16/05 23:01 00:01 UK Rightmove House Price Index y/y : May 0.1% 0.0% n/a
23:50 08:50 Japan CGPI y/y : Apr 2.0% 2.1% 2.0%
23:50 08:50 Machinery Orders (sa) m/m : Mar -2.3% -11.0% -10.2%
(15/05)
08:00 10:00 Italy EU Trade Balance : Mar EUR-0.9bn EUR-0.2bn n/a
09:00 11:00 CPI (Final) m/m : Apr 0.5% (p) 0.5% 0.5%
09:00 11:00 CPI (Final) y/y : Apr 2.6% (p) 2.6% 2.6%
09:00 11:00 HICP (Final) m/m : Apr 1.1% (p) 1.1% 1.1%
09:00 11:00 HICP (Final) y/y : Apr 3.0% (p) 3.0% 3.0%
09:00 11:00 Eurozone HICP m/m : Apr 1.4% 0.5% n/a
09:00 11:00 HICP y/y : Apr 2.7% 2.8% n/a
09:00 11:00 HICP Core m/m : Apr 1.4% 0.5% n/a
09:00 11:00 HICP Core y/y : Apr 1.3% 1.6% n/a
09:00 11:00 Foreign Trade Balance (nsa) : Mar EUR-1.5bn EUR1.0bn n/a
11:30 13:30 Eurogroup Finance Ministers Meet EU Parliament Officials
15:00 17:00 Eurozone Finance Ministers Meet
12:30 08:30 US Empire State Survey : May 21.7 19.0 20.0
13:00 09:00 TICS Data : Mar USD97.7bn USD20.0bn n/a
13:00 09:00 Fed’s Bernanke Speaks at Forum on Intangible Assets in Washington
14:00 10:00 NAHB Housing Market Index : May 16 16 17

Tue 17/05 01:30 11:30 Australia RBA MPC Minutes

Norway Public Holiday
06:00 08:00 Eurozone EU25 New Car Registrations : Apr
06:30 08:30 Ecofin Meeting of European Finance Ministers
08:30 09:30 UK CPI m/m : Apr 0.3% 0.7% 0.7%
08:30 09:30 CPI y/y : Apr 4.0% 4.3% 4.1%
08:30 09:30 RPI y/y : Apr 5.3% 5.4% 5.3%
08:30 09:30 RPIX y/y : Apr 5.4% 5.5% 5.3%
08:30 09:30 DCLG House Prices : Mar 0.7% 0.7% n/a

Market Economics 12 May 2011

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Economic Calendar: 13 - 20 May (cont)
GMT Local Previous Forecast Consensus
Tue 17/05 09:00 11:00 Germany ZEW Expectations : May 7.6 2.6 5.0
(cont) 09:00 11:00 ZEW Current Assessment : May 87.1 87.1 88.0
12:30 08:30 US Housing Starts : Apr 549k 570k 570k
13:15 09:15 Industrial Production m/m : Apr 0.8% 0.5% 0.4%
13:15 09:15 Capacity Utilisation Rate : Apr 77.4% 77.4% 77.6%

Wed 18/05 23:50 08:50 Japan Tertiary Index (sa) m/m : Mar 0.8% -6.5% -5.7%
(17/05)
00:30 10:30 Australia Westpac Consumer Confidence : May 105.3 104.1 n/a
07:00 09:00 Eurozone ECB’s Stark Speaks in Athens
07:00 09:00 ECB’s Bini Smaghi Speaks in Milan
09:30 11:30 ECB’s Constancio Speaks at EU Conference in Brussels
08:00 10:00 Spain GDP (Final) q/q : Q1 0.2% 0.2% n/a
08:00 10:00 GDP (Final) y/y : Q1 0.6% 0.7% n/a
08:30 09:30 UK Unemployment Change : Apr 0.7k 0.0k 1.0k
08:30 09:30 Unemployment Rate (Claimant) : Apr 4.5% 4.5% 4.5%
08:30 09:30 Average Earnings (3m-y/y) : Mar 2.2% 2.3% 2.0%
08:30 09:30 BoE MPC Minutes
14:30 10:30 US EIA Oil Inventories
18:00 14:00 FOMC Minutes
23:00 19:00 Fed’s Bullard Speaks at Money Marketeers in New York

Thu 19/05 23:50 08:50 Japan GDP (Prel) q/q : Q1 -0.3% -0.8% -0.5%
23:50 08:50 GDP (Prel) q/q Annualised : Q1 -1.3% -3.0% -2.0%
23:50 08:50 GDP (Prel) y/y : Q1 0.0% 0.3% n/a
(18/05)
07:30 09:30 Neths Unemployment Rate : Apr 5.3% 5.3% n/a
08:30 09:30 UK Retail Sales Inc Autos m/m : Apr 0.2% 0.5% 1.0%
08:30 09:30 Retail Sales Inc Autos y/y : Apr 1.3% 2.4% 2.7%
10:00 11:00 CBI Monthly Industrial Trends : Apr
12:30 08:30 US Initial Claims 434k 425k n/a
14:00 10:00 Philadelphia Fed Survey : May 18.5 17.0 23.0
14:00 10:00 Existing Home Sales : Apr 5.10mn 5.30mn 5.20mn
14:00 10:00 Leading Indicators m/m : Apr 0.4% 0.0% 0.1%
Fed’s Dudley Speaks on Regional Economic Conditions in New York
17:40 13:40 Fed’s Evans Speaks at Global Corporate Treasurers Forum in Chicago
13:00 15:00 Eurozone ECB’s Trichet and Tumpel-Gugerell Speak in Frankfurt

Fri 20/05 Japan BoJ Rate Announcement

06:00 08:00 Germany PPI m/m : Apr 0.4% 0.7% 0.6%
06:00 08:00 PPI y/y : Apr 6.2% 6.1% 6.0%
07:30 09:30 Neths Consumer Confidence : May -10 -12 n/a
07:30 09:30 Eurozone ECB’s Mersch Speaks at Luxembourg Conference
08:00 10:00 Current Account (sa) : Mar EUR-7.2bn EUR-4.0bn n/a
08:00 10:00 Italy Industrial Orders y/y : Mar 16.2% 11.6% n/a
09:00 11:00 Non-EU Trade Balance : Apr EUR-2.8bn EUR-1.6bn n/a
11:00 07:00 Canada CPI m/m : Apr 1.1% 0.4% 0.5%
11:00 07:00 CPI y/y : Apr 3.3% 3.4% 3.4%
13:00 15:00 Belgium Consumer Confidence : May -1 0 n/a
US Fed’s Dudley Speaks on Regional Economic Conditions in New York

Release dates and forecasts as at c.o.b. prior to the date of publication: See Daily Economic Spotlight for any revision Source: BNP Paribas

Market Economics 12 May 2011

Market Mover 63 www.GlobalMarkets.bnpparibas.com
Key Data Preview
Chart 1: German PMI & GDP Growth BNP Paribas Forecast: Acceleration from Q4
Germany: GDP (Q1 2011, ‘Flash’ Estimate)
65 2.0
Release Date: Friday 13 May
60 Composite PMI
(Output) 1.0 We forecast a marked acceleration in the q/q rate of growth
55
in GDP in Q1, in line with indications from the hard activity
50 0.0 data and sentiment surveys (see chart).
45 The composite PMI, which reflects business activity in the
-1.0
40 manufacturing and service sectors, had an average level of
-2.0
over 60 for the first time in its history in Q1. Ifo’s business
35
climate index also reached a 40-year high.
30 German GDP
(% q/q, RHS) -3.0 Industrial output is on track to rise by around 2½ q/q in Q1,
25
the fastest rate of growth since Q2 2010 when GDP rose
20
98 99 00 01 02 03 04 05 06 07 08 09 10 11
-4.0 by more than 2% q/q. Growth in the final quarter of 2010
was depressed by exceptionally cold weather: construction
Source: Reuters EcoWin Pro output plunged by over 6% q/q.
Seas. Adjusted Q1 11 (f) Q4 10 Q3 10 Q2 10 Capex has been a key source of growth in recent quarters.
It increased at an average rate of over 4% q/q during 2010
GDP % q/q 1.0 0.4 0.7 2.3 and with the level as of Q4 last year still over 10% down on
GDP % y/y 4.4 4.0 3.9 3.9 its pre-financial crisis peak, the strength should persist.
Private consumption growth has been more sluggish. The
Key Point: q/q rate of growth in retail sales in Q1 was a meagre 0.2%.
Sentiment surveys and hard data point to an In addition, trade data point to slower export growth.
acceleration in the q/q growth rate in GDP. The forecast 1.0% q/q rise in GDP in Q1 would see the y/y
rate of growth rise to 4.4%, the highest since Q4 2006. The
2011 growth rate should be similar to 2010’s 3.5%.

Chart 2: French GDP vs. Industrial Production BNP Paribas Forecast: Much Stronger
1.5 4 France: GDP (Q1, First Estimate)
GDP (% q/q) 3
1.0 Release Date: Friday 13 May
2
0.5 1 In Q4 2010, GDP growth was driven by final demand.
0 Private consumption was particularly strong, up 0.9% q/q.
0.0 -1 Nevertheless, growth was a modest 0.4% q/q. Exports and
-0.5
-2 private investments did reasonably well (1.0% and 0.6%
-3 respectively). However, the collapse of inventories, which
-1.0 -4 contracted by the equivalent of 1.7% of GDP (i.e. two days
-5
-1.5 of total output) lowered total growth, even though it also
-6
-7
resulted in a fall of imports (-1.2%).
-2.0
IP (% 3m/3m, RHS) -8 The growth pattern in Q1 2011 will be very different. The
-2.5 -9 main difference should come from a smaller decline of
02 03 04 05 06 07 08 09 10
inventories that should be associated with a rebound of
Source: Reuters EcoWin Pro imports. Exports are also expected to speed up.
Meanwhile, consumption will remain strong, but probably
Volume SA-WDA Q1 (f) Q4 Q3 Q1 10 not as much as in Q4 (retail sales rose 1.2% q/q early this
GDP % q/q 0.8 0.4 0.2 0.3
year versus 1.8% at the end of 2010).
GDP % y/y 2.0 1.5 1.7 1.2 Altogether, growth is forecast at 0.8% q/q. This is
PCE % q/q 0.5 0.9 0.5 0.0
consistent with a rise in industrial production of at least
2.0% q/q, assuming it is unchanged m/m in March (a
External contrib. (pt) -0.2 0.6 -0.4 0.7
conservative hypothesis). This quarterly gain would be the
strongest since Q1 2007 and would raise the y/y growth
Key Point: rate to 2.0%, a touch above potential.
Q1 GDP growth is forecast to be double the pace of
Q4 2010. However, much of the acceleration reflects
a much smaller contraction of inventories.

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64
Key Data Preview
Chart 3: French Employment and Wages (% y/y) BNP Paribas Forecast: Up Slightly
5 France: Non-Farm Payrolls and Wages (Q1)
4 Employment (% y/y) Release Date: Friday 13 May
Monthly Wage (% y/y)
3 We forecast GDP jumped 0.8% q/q in Q1. However, non-
farm payrolls are driven more by the growth rate of the
2
previous quarter than that of the current quarter.
1 Consequently, we expect employment to rise 0.3% q/q in
Q1 after 0.2% in Q4, following GDP growth of 0.36% q/q in
0
Q4, a little stronger than in Q3 (+0.24%).
-1
This would also be consistent with the decline of
-2 unemployment seen over Q1 (-43k), the sharpest fall for
-3
three years.
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 The trend rise in wages has been extremely stable for a
long time in France (see chart). It took a deep recession to
Source: Reuters EcoWin Pro lower wage growth below 2.0%. As growth has returned,
we expect a gradual rise over the 2.0% threshold but not
% Q1 (f) Q4 Q3 Q1 10 before the second quarter of this year. Wage earners are
NF Payrolls (sa) q/q 0.3 0.2 0.1 0.1 very concerned about their purchasing power but seem
NF Payrolls y/y 0.9 0.8 0.6 -0.9 unable to secure general wage increases apart from in a
Monthly Wage nsa q/q 0.9 0.3 0.3 0.7
few large corporations. Most workers are left with bonuses
and promotion as the only source of income gains, which
Monthly Wage y/y 1.9 1.8 1.7 1.8
explains why wage growth remained in a narrow range of
2.4% to 2.9% in the 8 years before the financial crisis, from
Key Point: 2001 to 2008.
Employment gains are speeding up as growth picks
up. We expect wage growth to rise slightly.

Chart 4: Eurozone GDP Growth & PMI BNP Paribas Forecast: Q1 Acceleration
65 1.5
Eurozone: GDP (Q1 2011, ‘Flash’ Estimate)
60 1.0 Release Date: Friday 13 May
55 0.5 Survey data are indicative of an acceleration in the q/q rate
50 0.0
of GDP growth in Q1, following a 0.3% increase in the final
quarter of 2010. In line with the composite PMI (see chart),
45 -0.5
Composite PMI: we forecast a 0.7% q/q rate of growth, which would see the
Output
40 -1.0 y/y rate rise to 2.3%, the highest since Q3 2007.
35 -1.5 On the expenditure side, exports continue to grow but trade
data are indicative of a continuation of the slowdown which
30 -2.0
became evident in the second half of 2010. Capex should
GDP (% q/q, RHS)
25 -2.5 remain robust, with capacity utilisation rates elevated and
20 -3.0 business sentiment very strong. Surveys of shortages of
98 99 00 01 02 03 04 05 06 07 08 09 10 11
equipment have also been rising in recent quarters.
Source: Reuters EcoWin Pro Private consumption rose by an average of 0.3% q/q during
the four quarters of 2010 and retail sales figures for Q1 to
Seas. Adjusted Q1 11 (f) Q4 10 Q3 10 Q2 10 date signal another quarter of subdued growth in spending.
GDP % q/q 0.7 0.3 0.4 1.0 High inflation is dampening household real income growth
GDP % y/y 2.3 2.0 2.0 2.0 even though the labour market is improving again.
Divergence at the national level will again be evident in the
Q1 data, with Germany and other core countries likely to
Key Point:
continue to grow at a much faster rate than the distressed
Sentiment surveys and hard activity data signal a
peripheral countries.
pick-up in eurozone growth in Q1.
Our forecast for eurozone growth during 2011 as a whole is
1.8%, similar to 2010’s 1.7% increase. Germany will again
be the star performer, with growth forecast at 3.4%.

Market Economics 12 May 2011

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Key Data Preview
Chart 5: Italian GDP vs. Business Confidence BNP Paribas Forecast: Rebound
Italy: GDP (Q1, Preliminary)
Release Date: Friday 13 May
Leading indicators and available hard data are consistent
with a modest acceleration in growth from Q4. On the
output side, industrial production should have recorded a
modest q/q rise (March data are not yet available) following
the 0.6% decline reported at the end of last year.
On the demand side, growth continues to be led by
exports, which accelerated from Q4. Conversely,
household spending remained subdued, as suggested by
sluggish retail sales, on the back of weak labour market
conditions and higher imported inflation.
Greater optimism amongst businesses and improved credit
Source: Reuters EcoWin Pro conditions point to some recovery in investment spending
but, overall, growth in final domestic demand should
Q1 (f) Q4 Q3 Q2 remain moderate.
GDP % q/q 0.3 0.1 0.3 0.5 The forecast is surrounded by a high degree of uncertainty
GDP % y/y 1.3 1.5 1.4 1.5 due to inventories. In Q4 stock building added 1.1pp to
quarterly growth. We assume this will partially unwind in
Key Point: Q1 but there is potential for a larger drag on growth from
GDP is likely to rebound from Q4, due to a stronger this component than we anticipate.
export performance. Domestic demand remains For 2011 as a whole, we expect growth to average 0.9%,
sluggish, however. slightly lower than 2010’s 1.2% reading and below our
expectations for eurozone growth of 1.8%.

Chart 6: Spanish GDP vs. Economic Sentiment BNP Paribas Forecast: Modest Growth
Spain: GDP (Q1, Flash)
Release Date: Friday 13 May
Available hard data and leading indicators suggest growth
remained modest in Q1.
Export demand continued to support activity in the
manufacturing sector but a corrosive combination of fiscal
corrective measures, higher inflation and poor
developments in the labour market probably hit household
demand. The decline in retail sales accelerated in March.
While seasonal factors – Easter fell late this year – might
have exacerbated these developments, the underlying
trend is weak suggesting consumer demand contracted,
albeit marginally, in Q1. We assume investment in
Source: Reuters EcoWin Pro machinery resumed but this should be more than offset by
a further drop in housing investment, leaving overall
Q1 (f) Q4 Q3 Q2 domestic demand lower than in Q4 last year.
GDP % q/q 0.2 0.2 0.0 0.3 On the other hand, we expect net trade to have continued
GDP % y/y 0.7 0.2 0.0 -1.4 to post a positive contribution to growth, thanks to a further
slowdown in import growth combined with exports’
Key Point: resilience.
Domestic demand is likely to have fallen again in Q1. Overall, GDP is expected to have grown by 0.2% q/q, the
Net exports remain the only driver of the modest same pace as in Q4. With global manufacturing activity
growth. expected to slow over the next few months, the Spanish
economy is likely to remain weak for the reminder of the
year. Our average forecast for 2011 remains 0.3%, well
below the consensus and government estimates.

Market Economics 12 May 2011

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66
Key Data Preview
Chart 7: US Core CPI Inflation BNP Paribas Forecast: Headline Pushes Higher
US: Consumer Price Index (April)
Release Date: Friday 13 May
Consumer prices are expected to increase another 0.4% in
April, after a similar gain in the previous four months, on
the back of further gains in gasoline and food prices.
Gasoline prices are expected to increase by another
7.6% m/m while food prices are forecast to increase 0.5%
as rising global spot prices work their way through to the
retail level.
Our forecast would lead the annual pace of overall inflation
to accelerate to 3.1% y/y from 2.7% in March. This would
be the fastest pace of headline inflation since October
2008 and we expect a further acceleration to 3.6% by
Source: Reuters EcoWin Pro September, a pace substantially faster than wage growth.
However, we expect inflation to come down quickly
% m/m Apr (f) Mar Feb Jan thereafter as the pace of gains in both energy and core
CPI 0.4 0.5 0.5 0.4 prices moderates.
Core 0.2 0.1 0.2 0.2 Excluding food and energy, we expect the core CPI to rise
NSA (index) 224.851 223.467 221.309 220.223 0.2% as firms try to pass on higher input costs. Our
forecast would lead the annual pace of core inflation to
accelerate to 1.4% y/y from 1.2% in March and up from the
Key Point:
record low of 0.6% reached in October 2010.
Food and energy prices will continue to push
headline inflation higher and some pass-through
means another firm core print.

Chart 8: US Confidence is Slowly Improving BNP Paribas Forecast: Up Slightly

US: Michigan Consumer Sentiment (May, Preliminary)
Release Date: Friday 13 May
The final April reading on consumer confidence from the
University of Michigan inched up to 69.8 rising 0.2pp from
the preliminary number. It was above March’s 67.5 level
but well below the 77.5 reading in February reflecting the
continued challenges facing consumers. In the beginning of
May we expect a further improvement and the University of
Michigan index is forecast to increase to 70.0 from 69.8. In
the beginning of May stock markets continued to rally
helped by better than expected corporate earnings.
Nonetheless, gasoline prices continued to rise while wages
have failed to accelerate. Hence, further increases in
Source: Reuters EcoWin Pro
consumer confidence measures should remain limited.

May p (f) Apr 2H Apr p Apr Mar

Michigan
Sentiment 70.0 71.0 69.6 69.8 67.5

Key Point:
We expect some improvement in consumer
confidence in May. The University of Michigan index
is expected to increase to 70.0 from 69.8.

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Key Data Preview
Chart 9: Japanese CGPI (2005=100) BNP Paribas Forecast: Rise
114 Japan: CGPI (April)
Release Date: Monday 16 May
112
We expect the domestic CGPI to climb 0.5% m/m in April
110 (0.6% m/m in March), a second straight month of robust
growth led by petroleum products, chemicals and
108
iron/steel. Despite continued softness in the processing
106 industries, the index has been on the rise since last
Total
October.
104
First, it was propelled by the resurgent global commodities
102 Excluding electric market, reflecting robust demand from China and other
power, gas & water emerging economies (fuelled in part by the developed
100 countries’ monetary easing, especially the Fed’s QE2).
06 07 08 09 10 11
Later, when commodities such as nonferrous metals and
Source: Reuters EcoWin Pro grain corrected in the latter part of February, the engine
became petroleum products, reflecting soaring prices for
Apr (f) Mar Feb Jan crude oil amid escalating geopolitical turmoil in North
CGPI (% y/y) 2.1 2.0 1.7 1.5 Africa/Middle East. Iron and steel prices, meanwhile, are
CGPI (% m/m) 0.5 0.6 0.2 0.5 on the rise thanks to soaring costs for materials such as
scrap iron since late 2010.
Key Point:
We expect the domestic CGPI to continue rising
robustly, led by petroleum products reflecting the
surge in crude oil prices in February-April on
geopolitical turmoil in North Africa/Middle East, as
well as resurgent Asian demand fuelled by monetary
easing in the developed nations.

Chart 10: Japanese Machinery Orders (JPY bn) BNP Paribas Forecast: Sharp Drop
Japan: Machinery Orders (March)
1300
Release Date: Monday 16 May
1200
We expect core machinery orders to plunge 11.0% m/m in
3M average
1100 March, reflecting the effect of the Great East Japan
Earthquake. Before the disaster, domestic appetite for
1000
capital investment was gradually reviving on the back of
900 the upturn in the global manufacturing cycle. But the
11 March earthquake and tsunami dramatically cast a
800
shadow over the economy’s future, probably prompting
700 many companies to hold back on machinery orders.
600
Companies hit hard by the disaster have already begun to
00 01 02 03 04 05 06 07 08 09 10 11 take steps to repair/replace damaged capital stock and/or
to shift/beef up production in unaffected areas – factors
Source: Cabinet Office, BNP Paribas that should bolster orders in coming months.
On the other hand, corporate income is set to take a big hit
Mar (f) Feb Jan Dec as disrupted supply chains impair production in areas not
Core (% m/m) -11.0 -2.3 4.2 1.7 otherwise affected by the disaster. Moreover, the growing
possibility that power deficiencies will persist beyond this
Key Point: summer should induce firms to focus on investment
abroad. Consequently, we do not expect domestic capital
Due to increased uncertainties after the Great East investment to recover robustly in the latter half of 2011.
Japan Earthquake, many firms probably put off
orders in March.

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Key Data Preview
Chart 11: Eurozone HICP BNP Paribas Forecast: Core Higher
Eurozone: HICP (April)
Release Date: Monday 16 May
We expect the final release to confirm that headline
inflation in the eurozone rose to 2.8% y/y in April – its
highest level since October 2008. Ex-tobacco is expected
at 112.68.
More importantly, the breakdown should reveal a chunky
increase in core inflation from 1.3% to 1.6% y/y – its
highest level since April 2009 and 0.8pp up on its February
2010 low.
The late timing of Easter compared with 2010 has boosted
leisure prices (predominantly package holiday prices) in
April, and to a lesser extent, hotel and restaurant prices.
Source: Reuters EcoWin Pro This dynamic was evident in Germany, where core inflation
jumped by 0.7pp, which on its own contributes 0.2pp of the
Apr (f) Mar Feb Jan increase in eurozone inflation.
HICP % m/m 0.5 1.4 0.4 -0.7 Part of this increase will unwind in May as the seasonals
HICP % y/y 2.8 2.7 2.4 2.3 normalise, but core inflation is on an upward trend.
Core % m/m 0.5 1.4 0.3 -1.6
Energy inflation has been one of the key drivers of
Core % y/y 1.6 1.3 1.0 1.1 headline inflation’s rise in recent months, but in April it
should act as a drag as last year’s strong price increase is
Key Point: not matched.
We expect an increase in core inflation, boosted by
the timing of Easter as well as pass-through from
higher commodity prices.

Chart 12: UK CPI vs RPI BNP Paribas Forecast: Rebound

UK: CPI (April)
Release Date: Tuesday 17 May
In March, UK CPI and RPI inflation posted a rare
downward surprise relative to consensus. The key reason
for the deceleration was food, which saw its year-on-year
inflation rate slow to 4.6% y/y from 6.3% the previous
month.
This slowdown in inflation should prove a blip on inflation’s
progress upwards towards a Q4 high. In April, we expect
headline CPI to rebound to 4.3% from 4.0% y/y, regaining
most of March’s lost ground.
Food inflation is expected to resume its progress higher –
the soft commodity price surge over the past six months is
Source: Reuters EcoWin Pro yet to fully pass through into the consumer data. But the
largest contribution should come from housing and utility
Apr (f) Mar Feb Jan inflation. April is an important month for rents and
CPI % m/m 0.7 0.3 0.7 0.2 anecdotal reports from the RICS suggest there could be
CPI % y/y 4.3 4.0 4.4 4.0 quite strong increases. This component will also be
RPI Index 234.9 232.4 231.2 229.0 boosted as last April’s decline in gas prices drops out of the
RPI % y/y 5.4 5.3 5.4 5.1 year-on-year comparison.
RPIX % y/y 5.5 5.4 5.5 5.1 Looking ahead, inflation in the UK is expected to continue
higher, peaking at close to 5% y/y in October. RPI inflation
Key Point: is expected to peak at close to 6%.
Inflation should rebound in April, making up much
of March’s lost ground on strong rent price
increases and utility bill base effects.

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Market Mover 69 www.GlobalMarkets.bnpparibas.com
Key Data Preview
Chart 13: Germany ZEW Breakdown BNP Paribas Forecast: Mixed Picture
100 100
Expectations (RHS) Current Assessment Germany: ZEW Survey (May)
75 75
Release Date: Tuesday 17 May
50
The ZEW expectations index fell in both March and April,
50
with the fall in the latter the biggest since September 2010.
25 Concern about the impact of events in Japan, high oil
25
prices, the start of the ECB hiking cycle, problems in the
0
0
periphery of the eurozone, and weaker growth in key
-25 export markets such as China have all contributed to the
-25 slump in expectations – and point to a further fall in May.
-50
In contrast, the assessment of current economic conditions
-50
-75 continued to improve in April: it is two years, in fact, since it
-100 -75
last registered a month-on-month decline.
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
The ZEW survey data reflect the opinions of approximately
Source: Reuters EcoWin Pro 300 analysts and fund managers, unlike other survey data,
such as Ifo’s business climate index, which is derived from
May (f) Apr Mar Feb the opinions of actual businesses.
Expectations 2.6 7.6 14.1 15.7 This makes the ZEW survey very sensitive to recent data,
Current Conditions 87.1 87.1 85.4 85.2 which have been mixed. Manufacturing orders fell by
Average 44.9 47.4 49.8 50.5 4% m/m in the most recent release, while export growth (at
7% m/m) was exceptionally strong (March data in both
cases).
Key Point:
Expectations are forecast to continue to slide, due With the index of current conditions near its record high
to a series of adverse factors. The index of current (see chart), there is limited upside from here and we
conditions is topping out. forecast a sideways move in May.
The hybrid index, combining expectations and the current
assessment, has fallen from its peak but remains at a level
consistent with robust GDP growth (around 4% y/y).

Chart 14: US Housing Starts & Building Permits BNP Paribas Forecast: Bounce Up
US: Housing Starts (April)
Release Date: Tuesday 17 May
In March, housing starts increased 7.2% m/m after an
18.5% m/m drop in the previous months. In April, we expect
housing starts to continue to improve moderately, rising
3.8% to 570k. This should bring the level of new
construction more in line with the level of building permits.
In addition, construction hours worked picked up 0.4% m/m
in April, also pointing to a moderate increase in housing
starts.
Overall, we believe housing starts have bottomed out.
However, they should continue bouncing around the bottom
for most of this year before starting to gradually rise again
Source: Reuters EcoWin Pro next year.
Apr (f) Mar Feb Jan
Housing Starts
(000s, saar) 570 549 512 628

Key Point:
In April, we expect housing starts to continue to
improve moderately, rising 3.8% to 570k, which
should bring the level of new construction more in
line with the level of building permits.

Market Economics 12 May 2011

Market Mover www.GlobalMarkets.bnpparibas.com
70
Key Data Preview
Chart 15: US Industrial Production BNP Paribas Forecast: Still Positive

3 Hurricane Distortion Aggregate Hours Worked (% m/m) US: Industrial Production (April)
Release Date: Tuesday 17 May
2
We look for industrial production to rise in April by
1
0.5% m/m after a strong 0.8% gain in March.
0 Manufacturing production has been in line in with the
-1 recent strength seen in manufacturing surveys; however
-2 April’s manufacturing surveys have softened suggesting
some weakening in April’s industrial production. Auto
-3
production has also shown signs of weakness with a
-4 Industrial Production (% m/m)
significant contraction in April. However, aggregate hours
-5 worked in the manufacturing industry increased by a solid
Apr 06 Apr 08 Apr 10 0.2% m/m for April. In addition, electric utility output
increased for the month.
Source: Reuters EcoWin Pro Recall the mining sector posted a strong 0.6% m/m reading
in March. We expect a similar reading for April. Utility
Apr (f) Mar Feb Jan production has remained volatile in recent months, and
Ind. Prod. (% m/m) 0.5 0.8 0.0 0.2 remains a risk to our forecast. Our forecast would imply
Cap. Util (%) 77.4 77.4 76.9 76.9 that capacity utilisation remains steady at 77.4%.

Key Point:
Manufacturing surveys and vehicle production point
to a slowing in industrial production for April, while
aggregate hours worked and utility output provide
some support.

Chart 16: UK BoE Agents Report on Employment BNP Paribas Forecast: Still Rising
Intentions
UK: Labour Report (April)
Release Date: Wednesday 18 May
The Q1 GDP data showed a rise of 0.5% q/q after a snow-
induced fall the previous quarter. While the underlying
trend of GDP looked flat taking the two quarters together,
weakness in utilities and North Sea activities probably
understated the trend. Moreover, actual activity rather than
the smoothed trend is what will have affected a lot of hiring
decisions. Thus expect employment to have increased and
claimant count employment to have been more or less flat.
The latest Bank of England agents’ survey shows that
manufacturers’ employment intentions have picked up over
the last three months, though prospects for consumer
Source: Reuters EcoWin Pro services look a little weaker. The trend in redundancies has
been down. However, the most recent surveys of business
Apr (f) Mar Feb Jan and consumer confidence have been weak, suggesting
Claimant Count Chg 0.0 0.7 -8.5 3.7 some slackening in the pace of hiring.
ILO Unemp 3m-chg -25k -18k 27k The major uncertainty about the figures relates to hiring
ILO Emp 3m-Chg 125k 144k 32k patterns given the extended holidays many people took to
Ave Earns % 3m/yr 2.1 2.0 2.3 bridge the gap between the unusually late Easter and the
Ex Bonus % 3m/yr 2.3 2.2 2.3 Royal Wedding and May Day Bank holidays. We expect
that hiring will have tended to be thin in this period. This
could distort the ILO unemployment figures up and
Key Point:
employment figures down. As for the claimant count, this
Employment should have responded to actual
took place on 14 April so should be less affected.
growth in Q1, which bounced back from poor
weather. The long holidays at the end of the month
could distort ILO employment down.

Market Economics 12 May 2011

Market Mover 71 www.GlobalMarkets.bnpparibas.com
Key Data Preview
Chart 17: Japanese Real GDP (sa, % q/q) BNP Paribas Forecast: Contraction
Japan: GDP (Q1 2011)
4
Release Date: Thursday 19 May
3 Private inventory
2
We expect the first preliminary GDP estimates for Q1 2011
to show a sharp contraction of 0.8% q/q (-3.0%
1
annualised), for a second straight quarter of falls
0
(-0.3% q/q, -1.3% annualised in Q4 2010). The economy
-1
seemed to be turning around from sluggishness in Q4, with
-2
exports having revived from late 2010 on the back of the
-3 recovery in the global manufacturing cycle. The
External
-4 improvement was also partly due to factors related to
Domestic Demand Demand
-5 (excluding Private inventory) policy, including a pullback in consumer spending after a
-6 Q3 surge linked to a cigarette tax hike and the expiry of the
05 06 07 08 09 10 "eco car" subsidies.
Source: Cabinet Office, BNP Paribas However, economic activity plummeted after the
earthquake on 11 March, due to disrupted supply chains
Q1 11 (f) Q4 10 Q3 10 Q2 10 and reduced power supply. The economy was also hit by a
Real (% q/q) -0.8 -0.3 0.8 0.5 sharp deterioration in sentiment, which led households and
Real (% q/q ann) -3.0 -1.3 3.3 2.1 businesses to cut back sharply on spending. While the
0.3
earthquake occurred late in the quarter, the contraction in
Real (% y/y) 0.0 4.9 3.2
activity that followed it will probably be enough to bring the
growth rate in Q1 deep into negative territory.
Key Point:
Real GDP probably contracted in Q1 due to the
severe supply constraints resulting from the
earthquake.

Chart 18: UK Retail Sales BNP Paribas Forecast: Upward Blip

UK: Retail Sales (April)
Release Date: Thursday 19 May
Retail sales probably suffered a number of distortions in
April. These included the latest Easter since 1943 and the
warmest April since records began in 1659. Add to this the
Royal Wedding and the fact that many workers took the
opportunity to have eleven days away from work at the cost
of only 3 days’ leave (bridging the Easter to Royal
Wedding/Mayday holidays and you have a recipe for a
likely outlier in the retail sales data.
The weather (clothing, barbeque products, alcohol) and the
Royal Wedding (more inbound tourists, souvenirs) will have
boosted retail sales, although big-ticket items may have
Source: Reuters EcoWin Pro suffered.
On the other hand, the level of consumer confidence is
Retail Sales Apr (f) Mar Feb Jan miserable – back to the levels only normally seen in
% m/m 0.5 0.2 -0.9 1.3 recessions. This reflects prices rising by over 4% y/y on the
% y/y 2.4 1.3 1.1 5.0 CPI and by over 5% y/y on the RPI, while wages increased
% 3m/3m 0.0 0.3 0.0 0.2 by only a little over 2% in the year to March.
% 3m/yr 1.5 2.4 1.7 1.6 Thus April may see a relatively good number, but it will be a
blip on a miserable trend. If the number does get a lift then
Key Point: expect a pay-back in May.
The retail sales trend is suffering from squeezed real The y/y should rise sharply as there was a m/m fall of 0.6%
incomes and declining confidence. A series of in April last year.
distortions may give April a temporary boost, but
there should be a pay-back in May.

Market Economics 12 May 2011

Market Mover 72 www.GlobalMarkets.bnpparibas.com
Key Data Preview
Chart 19: US Existing and Pending Home Sales BNP Paribas Forecast: Up Again
US: Existing and New Home Sales (April)
Release Date: Thursday and Tuesday 19 and 24 May
Existing home sales are expected to increase further in
April rising to 5.30mn annualised units following the
previous month’s increase to 5.10mn.
Pending sales that are based on contract signings and lead
existing sales by one to two months increased by 5.1% in
March. In addition, mortgage applications to purchase
increased 1.8% m/m in April following a 6% increase in the
previous month. But contract cancellations due to some
appraisals not supporting the prices negotiated between
buyers and sellers will weigh on a more rapid growth in
housing demand this year.
Source: Reuters EcoWin Pro The latest pick-up in pending home sales and mortgage
applications might not necessarily end up in a measurable
Apr (f) Mar Feb Jan pick-up in mortgage closings and translate into an increase
Existing Home Sales in existing home sales. New home sales recovered from a
(millions saar) 5.30 5.10 4.92 5.40 42k plunge in February, rising to 300k in March. In April,
New Home Sales we could see some further improvement as new home
(thousands saar) 310 300 270 312 sales rise to an estimated 310k.
Overall, home sales should continue to improve modestly
Key Point: along with the labour market. The prospects look brighter
Sales of existing homes are expected to increase for existing homes, as distressed sales will continue to rob
further in April, rising to 5.30n annualised units in demand from new home sales and construction activity.
April while sales of new homes will rise to 310k.

Chart 20: Canadian Inflation BNP Paribas Forecast: Pull-back

Canada: CPI (April)
Release Date: Friday 20 May
We expect Canadian headline CPI to increase by 0.4% in
April, as inflation pulls back from its March surge. Due to
seasonal factors, headline inflation should increase to
3.4% y/y in April from the 3.3% y/y reading in April. There
continue to be commodity price pressures as the global
environment of higher energy and food prices continues.
Note that food, shelter and transportation prices make up
63.5% of the headline inflation index.
The Bank of Canada core CPI is expected to post a flat
reading for the month. Shelter prices are likely to be a
significant factor in April’s reading while inflation for
Source: Reuters EcoWin Pro recreation is expected to taper off.
m/m % Apr (f) Mar Feb Jan Looking forward, the main upside risks to our inflation
outlook is a larger commodity pass-through. However, the
Headline CPI 0.4 1.1 0.3 0.3
downside risks include the strengthening of the currency, a
Bank of Canada Core 0.0 0.7 0.2 0.0
deceleration in the growth of unit labour costs, and a more
pronounced correction in the housing market. On balance,
Key Point: inflation looks well contained with some volatile temporary
April inflation should provide some relief to higher factors.
inflation concerns, although short-term year-on-year
headline inflation is likely to remain high.

Market Economics 12 May 2011

Market Mover 73 www.GlobalMarkets.bnpparibas.com
Economic Calendar: 23 May - 17 June
23 May 24 May
Eurozone: PMIs (Flash) Eurozone: Industrial
May Orders Mar
Italy: ISAE Consumer UK: PSNCR Apr, PSNB
Confidence May Apr, CBI Distributive
Sweden: Labour Apr Trades Q1
Canada: Holiday Germany: Ifo Survey
May, GDP (Final) Q1
France: Industry Survey
May
Norway: GDP Q1
Neths: Producer
Confidence May
Belgium: Business
Confidence May
US: New Home Sales Apr
During Week: UK Nationwide House Prices May, Germany Import Price Index Apr, Retail Sales Apr
30 May 31 May
Holiday: US, UK Japan: Labour Apr, Hh
Eurozone: Retail PMI Consumption Apr, IP Apr
May Eurozone: HICP (Flash)
Spain: HICP (Flash) May May, Labour Apr
Sweden: Retail Sales Apr Germany: Labour Apr
Belgium: CPI May France: Retail Sales Apr,
Canada: GDP Mar & Q1 PPI Apr, Housing Starts
Apr
Italy: CPI (Flash) May, PPI
Apr
Norway: Retail Sales Apr
Switz: GDP Q1
US: S&P/Case-Shiller HPI
May, Chicago PMI May,
Consumer Conf May
Canada: BoC Rate Ann
During Week: UK Halifax House Prices May
6 Jun 7 Jun
Eurozone: PPI Apr Japan: Leading Indicator
Spain: Industrial Apr
Production Apr Australia: RBA Rate
Norway: Labour May Announcement, NAB
Business Survey May
Eurozone: Retail Sales
Apr
UK: BRC Retail Sales
Monitor May
Germany: Factory
Orders Apr
Switz: CPI May
US: Consumer Credit
May
During Week: UK Halifax House Prices May
13 Jun 14 Jun
Japan: Machinery Orders Japan: BoJ Rate Ann
Apr Eurozone: ECB Rate
Italy: Industrial Ann May
Production Apr UK: RICS House Prices
Holiday: Belgium, May, DCLG House Prices
France, Germany, Neths, Apr, CPI May
Norway, Switz France: CA Apr
Spain: CPI May
Sweden: CPI May
US: Retail Sales May,
PPI May, Business
Inventories Apr, NFIB
Small Bus Optimism May
Source: BNP Paribas Release dates as at c.o.b. prior to the date of this publication. See our Daily Spotlight for any revisions
Market Economics
Market Mover
25 May
Japan: BoJ Monetary
Policy Meeting Minutes,
Trade Balance Apr
UK: GDP (Prel) Q1
France: Job Seekers Apr
Italy: Retail Sales Mar
Spain: PPI Apr
US: Durable Goods
Orders Apr, FHFA House
Prices Mar
1 Jun
Australia: GDP Q1
Eurozone: Manufacturing
PMI (Final) May
UK: CIPS Manufacturing
May, Net Consumer
Credit Apr, Mortgage
Approvals Apr
Switz: PMI May
US: ADP Labour May,
Construction Apr, ISM
Manufacturing May,
Challenger Layoffs May
8 Jun
Japan: M2 May, Current
Account Apr
Australia: Wespac
Consumer Confidence
Jun
Eurozone: GDP (2nd Est)
Q1
Germany: Industrial
Production Apr, Trade
Balance Apr
France: Trade Balance
Apr, Budget Balance Apr
Norway: Industrial
Production Apr
Belgium: GDP Q1 (Final)
US: Beige Book
15 Jun
Eurozone: Industrial
Production Apr,
UK: Labour May
France: CPI May
Sweden: Labour May
US: Empire State Survey
Jun, CPI May, Industrial
Production May, TICS
Data Apr, NAHB HPI Jun
74
26 May
Germany: GfK Consumer
Confidence Jun
France: Consumer
Confidence May
Italy: ISAE Business
Confidence May
Sweden: Consumer
Confidence May, PPI Apr
Norway: Labour Mar
US: GDP (Final) Q1,
Corporate Profits Q1
2 Jun
Australia: Trade Balance
Apr, Retail Sales Apr
Holiday: Belgium, France,
Germany, Italy, Neths,
Norway, Sweden, Switz
US: Productivity & Costs
(Prel) Q1, Factory Orders
Apr
9 Jun
Japan: GDP (Rev) Q1
Australia: Labour
Eurozone: ECB Rate
Announcement & Press
Conference
UK: BoE Rate
Announcement, Trade
Balance Apr
Germany: LCI Q1
France: BoF Survey May,
Non-Farm Payrolls (Final)
Q1
Italy: LCI Q1
Neths: CPI May, IP Apr
US: Trade Balance Apr,
Wholesale Trade May
16 Jun
Eurozone: Employment
Q1, HICP May, ECB
Monthly Bulletin
UK: Retail Sales May
Italy: CPI May
Switz: SNB Rate
Announcement
Neths: Retail Sales Apr
US: New Home Starts
May, Philly Fed Survey
Jun, Current Account Q1
www.GlobalMarkets.bnpparibas.com
27 May
Japan: CPI Tokyo May,
CPI National Apr, Retail
Sales Apr
Eurozone: Eurocoin May,
Monetary Devs Apr, Bus &
Consumer Survey May
UK: GfK Consumer
Confidence May
Germany: CPI (Prel) May
Italy: Wages Apr
Spain: Retail Sales Apr
Sweden: GDP Q1
Switz: KoF Leading
Indicator May
US: PICE Apr, UoM (Final)
May, Pending Home Sales
Apr
3 Jun
Eurozone: Services PMI
(Final) May
UK: CIPS Services May
Norway: LCI Q1
US: Labour May, ISM
Services May
10 Jun
Japan: CGPI May,
Tertiary Index Apr
UK: Industrial Production
Apr, PPI May
Germany: CPI May
France: Industrial
Production Apr
Italy: GDP (Final) Q1
Norway: CPI May, PPI
May
Sweden: Industrial
Production Apr
US: Import Prices May,
Treasury Statement
Canada: Labour May
17 Jun
Japan: BoJ Monetary
Policy Meeting Minutes
Eurozone: Trade Balance
Apr
France: Wages (Final) Q1
Italy: EU Trade Balance
Apr
US: UoM Sentiment (Prel)
Jun, Leading Indicators
May
12 May 2011
Treasury and SAS Issuance Calendar

In the pipeline - Treasuries:

Portugal: May announce further changes to the Quarterly Funding Programme released 31 March
UK: Gilt (syndicated) in the second half of June (details around 2 weeks in advance)
UK: Index-Linked Gilt in the 20-25y area, via syndication, in the second half of May (details around 2 weeks in advance)
Belgium: Plans to launch a further new syndicated 15- or 20-year benchmark bond later this year depending on market conditions
Czech Rep.: May sell up to EUR 2bn of bonds in May
Hungary: Not planning to issue any more foreign currency denominated bonds this year
US: May issue cash-management bills during the quarter
In the pipeline - Agencies:
EFSF: Plans to issue a second benchmark bond, probably a 10y maturity, in Q2
During the week:
FHLB: May Global Notes auction details to be announced on Monday 16 May
FHLMC: Optional Reference Notes announcement on Thursday 19 May
Date Day Closing Country Issues Details BNPP forecasts
Local GMT
13/05 Fri 10:55 08:55 Italy BTP 3.75% 15 Apr 2016 EUR 2.5-3.5bn
BTP 5% 1 Sep 2040 EUR 1-1.75bn
16/05 Mon Slovak Rep. SLOVGB 14 Oct 2013 (#215 - floating rate) EUR 0.2bn
17/05 Tue 12:00 03:00 Japan JGB 20 Mar 2051 JPY 0.4tn
Denmark DGB 2% 15 Nov 2014
DGB 3% 15 Nov 2021
18/05 Wed 11:00 09:00 Germany OBL 2.75% 8 Apr 2016 (Series 160) EUR 6bn
11:00 09:00 Sweden T-bonds 3.5% 1 Jun 2022 (# 1054) SEK 2bn
12:00 16:00 Canada CAN 5-year 12 May
19/05 Thu 12:00 03:00 Japan JGB 20 Mar 2016 JPY 2.4tn
10:30 08:30 Spain Obligacion 5.5% 30 Apr 2021 16 May EUR 2.5-3.5bn
10:50 08:50 France BTANs 2- &/or 5-year 13 May EUR 7-9bn
11:50 09:50 France OATis , OATeis, BTANeis 13 May EUR 1.5-2bn
10:30 09:30 UK Gilt 2.25% 7 Mar 2014 GBP 5bn
13:00 17:00 US TIPS 1.125% 15 Jan 2021 USD 11bn
23/05 Mon 11:00 09:00 Norway NGBs 13 May
12:00 10:00 Belgium OLOs 16 May EUR 2.5-3.5bn
24/05 Tue 12:00 03:00 Japan Auction for Enhanced-liquidity 17 May JPY 0.3tn
13:00 17:00 US Notes 2-year (new) 19 May USD 35bn
25/05 Wed 11:00 09:00 Germany Bund 3.25% 4 Jul 2021 EUR 5bn
12:00 16:00 Canada CAN 3-year 19 May
13:00 17:00 US Notes 5-year (new) 19 May USD 35bn
26/05 Thu 12:00 03:00 Japan JGB 20-year 19 May JPY 1.1tn
10:55 08:55 Italy CTZ 23 May EUR 2.5bn
13:00 17:00 US Notes 7-year (new) 19 May USD 29bn
27/05 Fri 10:55 08:55 Italy BTPeis 23 May EUR 1.5-2bn
30/05 Mon 12:00 03:00 Japan JGB 2-year 23 May JPY 2.6tn
10:55 08:55 Italy 3 & 10y BTPs and CCT 23 May EUR 7-9bn
01/06 Wed 12:00 03:00 Japan JGB 10-year 25 May JPY 2.2tn
10:50 08:50 France OATs 27 May EUR 7-9bn
11:00 09:00 Sweden T-bonds 25 May SEK 2bn
12:00 16:00 Canada CANi 30-year 26 May
02/06 Thu 10:30 08:30 Spain Bono 3.4% 30 Apr 2014 30 May EUR 3-4bn
10:30 09:30 UK Gilt 3.75% 7 Sep 2021 24 May
12:00 16:00 Canada CAN 2-year (Repurchase - Switch) 26 May
03/06 Fri 12:00 03:00 Japan Auction for Enhanced-liquidity 27 May JPY 0.3tn
07/06 Tue 12:00 03:00 Japan JGB 30-year 31 May JPY 0.7tn
11:00 09:00 Austria RAGBs 31 May EUR 1-2bn
10:30 09:30 UK Index-Linked Gilt 0.625% 22 Mar 2040 31 May
Denmark DGBs 2 Jun
13:00 17:00 US Notes 3-year (new) 2 Jun USD 32bn
08/06 Wed 12:00 16:00 Canada CAN 30-year 2 Jun
13:00 17:00 US Notes 10-year 2 Jun USD 21bn
09/06 Thu 12:00 03:00 Japan JGB 5-year 2 Jun JPY 2.4tn
13:00 17:00 US Bond 30-year 2 Jun USD 13bn
Sources: Treasuries, BNP Paribas

Interest Rate Strategy 12 May 2011

Market Mover, Non-Objective Research Section 75 www.GlobalMarkets.bnpparibas.com
 Next Week's T-Bill Supply Next Week's Eurozone Redemptions
Date Country Issues Details Date Country Details Amount
13/05 UK T-Bills Jun 2011 GBP 1.5bn 18/05 Greece GGB 5.35% EUR 6.4bn
T-Bills Aug 2011 GBP 1.5bn Total Eurozone Long-term Redemption EUR 6.4bn
T-Bills Nov 2011 GBP 1.5bn 16/05 Italy BOT (12m) EUR 6.0bn
16/05 France BTF Aug 2011 EUR 3bn 16/05 Austria ATB (EU30) EUR 0.1bn
BTF Sep 2011 EUR 2bn 18/05 Germany Bubills EUR 6.0bn
BTF Nov 2011 EUR 1bn 19/05 France BTF EUR 8.6bn
BTF May 2012 EUR 1.5bn 19/05 Belgium TC EUR 8.0bn
Germany Bubills Feb 2012 EUR 2bn 20/05 Spain Letras EUR 7.9bn
Neths DTC Aug 2011 EUR 1.5-2.5bn 20/05 Greece GTB (26W) EUR 0.5bn
DTC Oct 2011 EUR 1.5-2.5bn Total Eurozone Short-term Redemption EUR 37.1bn
DTC Mar 2012 EUR 1-2bn Next Week's Eurozone Coupons
US T-Bills Aug 2011 USD 27bn
Country Amount
T-Bills Nov 2011 USD 24bn
FHLMC Bills 3-month & 6-month 13 May Austria EUR 0.1bn
17/05 Japan T-Bills May 2012 JPY 2.5tn Greece EUR 1.8bn
Spain Letras May 2012 16 May Portugal EUR 0.0bn
Letras Oct 2012 16 May Finland EUR 0.0bn
Total Long-term Coupon Payments EUR 1.9bn
Belgium TC Aug 2011 13 May
TC May 2012 13 May
US T-Bills 4-week 16 May Chart 1: Investors’ Net Cash Flows
FHLB Discount Notes
(EUR bn, 10y equivalent)
18/05 Japan T-Bills Aug 2011 JPY 4.8tn
Portugal BT Jul 2011 EUR 0.75-1bn 2
FNMA Bills 3-month & 6-month 16 May
0
19/05 Japan T-Bills Jul 2011 JPY 3tn
FHLB Discount Notes -2
20/05 UK T-Bills 13 May -4
Sources: Treasuries, BNP Paribas -6
-8
-10
-12 Net Investors' Cash Flows
(EUR bn , 10y equivalent)
-14
Comments and charts -16
Week of May 9th Week of May 16th Week of May 23rd Week of May 30th

„ EGB gross supply will increase slightly in the week Chart 2: EGB Gross Supply Breakdown by
ahead from EUR 15bn to EUR 19-20bn. In 10y duration Country (EUR bn, 10y equivalent)
adjusted terms it will increase even less, from
EUR 8.7bn to EUR 9.5bn, as there will not be any 20 Germany
France
Italy
Spain
Portugal
Netherlands
Belgium
Austria
supply in the longer end. The only long-term redemption 18 Finland Greece Ireland

will take place in Greece for an amount of EUR 6.4bn. 16

This is the second big redemption in Greece in 2011 14

after the Mar-11. 12

10
„ Germany will kick-off EGB issuance with a 8
reopening of the recently launched OBL Apr-16 for 6
EUR 6bn. Spain will return to the markets on Thursday 4
for a tap of its 10y benchmark SPGB Apr-21 for an 2
expected amount in the range of EUR 2.5-3.5bn. On the 0
same day, France will conduct its regular mid-month 2y Week of May 9th Week of May 16th Week of May 23rd Week of May 30th

and/or 5y BTAN auctions plus the index-linked auctions.

We expect a total amount in the range of EUR 9-13bn. Chart 3: EGB Gross Supply Breakdown by
„ Outside of the eurozone, the US will issue Maturity (EUR bn, 10y equivalent)
USD 11bn of TIPS Jan-21, the UK will tap the Gilt 16 EGBs Gross Supply (EUR bn, 10y equivalent)
Mar-14 for GBP 1.5-2bn. Japan, Canada, Sweden and
14 2-3-YR 5-7-YR
Denmark will also conduct auctions in the week ahead.
12 10-YR >10-YR

10

0
Week of May 9th Week of May 16th Week of May 23rd Week of May 30th

All Charts Source: BNP Paribas

Interest Rate Strategy 12 May 2011

Market Mover, Non-Objective Research Section 76 www.GlobalMarkets.bnpparibas.com
Central Bank Watch
Date of
Current Next Change in
Interest Rate Last Comments
Rate (%) Coming 6 Months
Change
EUROZONE
+25bp +25bp (7/7/11) We forecast a further 25bp rate hike in July, following the likely
Minimum Bid Rate 1.25
(7/4/11) upward revisions to the ECB’s inflation projections in June.
US
-75bp
Fed Funds Rate 0 to 0.25 No Change The FOMC is expected to maintain the funds rate at 0 to 0.25%
(16/12/08)
until June 2012. It will execute its QE2 programme through H1
+25bp
Discount Rate 0.75 No Change 2011; we no longer expect QE3.
(18/2/10)
JAPAN
-10bp
Call Rate 0 to 0.10 No Change
(5/10/10) We expect the BoJ to continue to respond to the developments
-20bp surrounding the earthquake disaster by expanding liquidity.
Basic Loan Rate 0.30 No Change
(19/12/08)
UK
Disappointing Q1 GDP data are likely to stand in the way of an
-50bp +25bp interest rate hike in the immediate few months. However, we
Bank Rate 0.5
(5/3/09) (4/8/11) expect better GDP data and rising wage pressures to provoke
the first rate hike in August.
DENMARK
Given recent downward pressures on the krone, we expect a
+25bp +35bp
Lending Rate 1.30 35bp rate hike in July. The risk is of a smaller, 25bp, hike in line
(7/4/11) (7/7/11)
with the ECB if the downward pressures on the krone abate.
SWEDEN
+25bp Higher inflationary pressures ahead and the upward trend in
+25bp
Repo Rate 1.75 (5/7/11) inflation expectations should lead to further rate hikes. We
(20/4/11)
expect the Riksbank to deliver the next hike at its July meeting.
NORWAY
Given the strengthening in economic data, higher house prices
+25bp +25bp
Sight Deposit Rate 2.25 and credit growth, we expect a further rate hike in September,
(12/5/11) (21/9/11)
with a risk of it coming as soon as August.
SWITZERLAND
The economy has continued to outperform despite the strength
3 Mth LIBOR Target -25bp +25bp of the franc, but the central bank remains very cautious about
0.0-0.75 (12/3/09)
Range (15/09/11) the exchange rate. We expect a hike in Q3 but the forecast
remains highly sensitive to the franc’s development.
CANADA
+25bp With a sharp pick-up in inflation in March, the BoC will consider
Overnight Rate 1.00 No Change increasing its overnight rate sooner than originally expected.
(8/9/10)
However, underlying inflation pressures remain subdued,
+25bp economic growth looks set to moderate and the currency is
Bank Rate 1.25 No Change
(8/9/10) strong. We expect the BoC to remain on hold until Q4 2011.
AUSTRALIA
The effective cash rate is moderately restrictive while financial
and monetary conditions are outright tight. Below-trend growth
+25bp
Cash Rate 4.75 No Change is likely this year, especially given the impact of the Queensland
(2/11/10)
floods. Underlying inflation is contained, albeit with upside risks.
There is little need for further tightening in the near term.
CHINA
We expect PBoC to hike at least twice more before the end of
1Y Bank Lending +25bp +25bp Q3. However, as M2 growth has slowed below 16%, the
6.31
Rate (6/4/11) (May/June) tightening of lending conditions should come to a halt. A major
shift in policy is unlikely before the Summer Economic Meeting.
BRAZIL
The Copom slowed the pace of tightening to 25bp in April. It
12.00 +50bp +25bp signalled that it prefers a gradual approach, reflected in 25bp
Selic Overnight Rate
(20/4/11) (8/6/11) hikes per meeting. This pace may prove too slow to re-anchor
steadily worsening inflation expectations.
Source: BNP Paribas Change since our last weekly in bold and italics
For the full EMK Central Bank Watch, please see our Local Markets Mover.

Market Economics 12 May 2011

Market Mover 77 www.GlobalMarkets.bnpparibas.com
 Economic Forecasts
GDP Year 2010 2011
(% y/y) ’10 ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 (1) Q2 (1) Q3 (1) Q4 (1)
US 2.9 2.4 3.1 2.4 3.0 3.2 2.8 2.3 2.2 2.4 2.6
Eurozone 1.7 1.8 1.5 0.8 2.0 1.9 2.0 2.2 1.6 1.6 1.6
Japan 3.9 -0.5 1.9 5.6 3.2 4.9 2.2 0.3 -1.0 -1.4 -0.3
World (2) -0.6 4.8 4.0 4.8 5.1 4.8 4.4 4.2 3.8 3.8 4.1

Industrial Production Year 2010 2011

(% y/y) ’10 ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 (1) Q2 (1) Q3 (1) Q4 (1)
US 5.3 5.1 4.0 1.5 6.5 6.9 6.3 5.8 5.6 4.6 4.5
Eurozone 7.2 4.6 1.8 4.6 9.0 6.9 7.9 6.5 4.9 4.2 2.7
Japan 16.5 -4.9 2.9 28.0 21.2 14.0 6.0 -2.5 -6.9 -10.2 -1.4

Unemployment Rate Year 2010 2011

(%) ’10 ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 (1) Q2 (1) Q3 (1) Q4 (1)
US 9.6 8.7 7.6 9.7 9.6 9.6 9.6 8.9 8.8 8.7 8.3
Eurozone 10.0 9.7 9.2 10.0 10.0 10.0 10.0 9.9 9.7 9.6 9.5
Japan 5.1 5.2 5.0 5.1 5.1 5.0 5.0 4.7 5.2 5.5 5.3

CPI Year 2010 2011

(% y/y) ’10 ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1)
US 1.6 3.1 1.6 2.4 1.8 1.2 1.3 2.1 3.4 3.5 3.3
Eurozone 1.6 2.9 2.0 1.1 1.6 1.7 2.0 2.5 2.9 3.1 3.2
Japan 0.1 0.5 0.7 -0.2 0.0 0.5 0.0 0.2 0.5 0.5 0.8

Current Account Year General Government Year

(1) (1) (1) (1) (1) (1)
(% GDP) ’10 ’11 ’12 (% GDP) ’10 ’11 ’12
US -3.2 -3.7 -3.4 US (4) -8.8 -10.5 -7.4
Eurozone -0.6 -0.6 -0.8 Eurozone -5.9 -4.4 -3.6
Japan 3.6 2.2 1.6 Japan -8.6 -11.3 -8.6

Interest Rate Forecasts

Interest Rate (3) Year 2011 2012
(%) ’10 ’11 (1) ’12 (1) Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)
US
Fed Funds Rate 0.25 0.25 1.00 0.25 0.25 0.25 0.25 0.25 0.25 0.75 1.00
3-month Rate 0.30 0.45 1.40 0.30 0.30 0.30 0.45 0.75 0.90 1.15 1.40
2-year yield 0.61 1.75 2.60 0.83 1.00 1.25 1.75 2.00 2.25 2.40 2.60
10-year yield 3.29 4.25 4.75 3.47 3.70 3.85 4.25 4.35 4.50 4.60 4.75
2y/10y Spread (bp) 268 250 215 264 270 260 250 235 225 220 215
Eurozone
Refinancing Rate 1.00 1.75 2.50 1.00 1.25 1.50 1.75 2.00 2.25 2.50 2.50
3-month Rate 1.01 2.20 3.00 1.24 1.50 1.90 2.20 2.25 2.50 2.75 3.00
2-year yield 0.85 2.80 2.80 1.80 2.05 2.35 2.80 2.95 3.05 3.10 3.15
10-year yield 2.96 3.95 4.00 3.37 3.45 3.70 3.95 4.00 4.10 4.10 4.00
2y/10y Spread (bp) 211 115 120 157 140 135 115 105 105 100 85
Japan
O/N Call Rate 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10
3-month Rate 0.34 0.35 0.35 0.34 0.35 0.35 0.35 0.35 0.35 0.35 0.35
2-year yield 0.18 0.25 0.30 0.22 0.25 0.25 0.25 0.30 0.30 0.30 0.30
10-year yield 1.12 1.40 1.50 1.26 1.30 1.40 1.40 1.40 1.40 1.50 1.50
2y/10y Spread (bp) 95 115 120 104 105 115 115 110 110 120 120
Footnotes: (1) Forecast (2) BNPP estimates based on country weights in the IMF World Economic Outlook Update
April 2010 (3) End Period (4) Fiscal year Figures are y/y percentage change unless otherwise indicated
Source: BNP Paribas

Market Economics / Interest Rate Strategy 12 May 2011

Market Mover www.GlobalMarkets.bnpparibas.com
78
FX Forecasts*
USD Bloc Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13
EUR/USD 1.45 1.50 1.40 1.40 1.35 1.33 1.30 1.30 1.30 1.30 1.30
USD/JPY 80 80 83 85 90 95 95 100 100 105 105
USD/CHF 0.88 0.87 0.93 0.94 0.99 1.02 1.08 1.08 1.08 1.06 1.06
GBP/USD 1.63 1.65 1.52 1.54 1.50 1.49 1.49 1.53 1.53 1.55 1.55
USD/CAD 0.98 0.96 0.97 0.97 0.97 0.98 0.98 1.00 1.00 1.02 1.02
AUD/USD 1.05 1.10 1.05 1.05 1.03 1.00 1.00 1.00 1.00 0.98 0.98
NZD/USD 0.78 0.79 0.77 0.79 0.77 0.75 0.77 0.77 0.77 0.76 0.76
USD/SEK 6.03 5.73 6.07 6.14 6.44 6.62 6.92 7.08 7.15 7.15 7.23
USD/NOK 5.24 4.98 5.29 5.25 5.46 5.60 5.77 5.90 5.96 5.96 5.92

EUR Bloc Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13
EUR/JPY 116 120 116 119 122 126 124 130 130 137 137
EUR/GBP 0.89 0.91 0.92 0.91 0.90 0.89 0.87 0.85 0.85 0.84 0.84
EUR/CHF 1.27 1.30 1.30 1.32 1.33 1.35 1.40 1.40 1.40 1.38 1.38
EUR/SEK 8.75 8.60 8.50 8.60 8.70 8.80 9.00 9.20 9.30 9.30 9.40
EUR/NOK 7.60 7.47 7.40 7.35 7.37 7.45 7.50 7.67 7.75 7.75 7.70
EUR/DKK 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46

Central Europe Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13
USD/PLN 2.72 2.60 2.71 2.79 2.85 2.86 2.88 2.85 2.77 2.85 2.85
EUR/CZK 24.5 24.3 24.5 24.1 23.9 23.8 23.5 23.7 24.0 23.5 23.3
EUR/HUF 280 275 275 269 265 265 260 260 255 260 260
USD/ZAR 6.90 6.80 6.60 6.55 6.60 6.50 6.50 7.20 7.10 7.00 6.90
USD/TRY 1.54 1.46 1.52 1.58 1.64 1.62 1.60 1.59 1.59 1.56 1.54
EUR/RON 4.05 4.20 4.15 4.20 4.15 4.10 4.05 4.20 4.20 4.10 3.95
USD/RUB 27.03 26.94 28.22 28.39 28.08 28.30 28.19 28.19 27.75 29.07 27.75
EUR/PLN 3.95 3.90 3.80 3.90 3.85 3.80 3.75 3.70 3.60 3.70 3.70
USD/UAH 7.9 7.8 7.8 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.3
EUR/RSD 115 105 100 98 97 96 95 93 92 91 90

Asia Bloc Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13
USD/SGD 1.23 1.22 1.21 1.21 1.20 1.19 1.18 1.17 1.16 1.15 1.14
USD/MYR 3.00 2.95 2.90 2.87 2.85 2.83 2.80 2.77 2.75 2.73 2.70
USD/IDR 8600 8500 8400 8300 8200 8100 8000 7900 7800 7800 7800
USD/THB 30.00 29.80 29.50 29.30 29.00 28.70 28.50 28.30 28.00 28.00 28.00
USD/PHP 42.50 42.00 41.50 41.00 40.50 40.00 39.50 39.00 39.00 39.00 39.00
USD/HKD 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80
USD/RMB 6.50 6.47 6.45 6.40 6.35 6.30 6.26 6.23 6.20 6.17 6.15
USD/TWD 28.00 27.70 27.30 27.00 26.70 26.50 26.00 26.00 26.00 26.00 26.00
USD/KRW 1070 1060 1050 1040 1030 1020 1010 1000 1000 1000 1000
USD/INR 46.00 45.50 45.00 44.50 44.00 43.50 43.00 43.00 42.50 42.50 42.00
USD/VND 20500 22550 22550 22550 22500 22500 22500 22500 22500 22500 22500

LATAM Bloc Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13
USD/ARS 4.06 4.12 4.20 4.28 4.35 4.42 4.50 4.60 4.70 4.80 4.90
USD/BRL 1.70 1.70 1.65 1.65 1.66 1.67 1.68 1.69 1.70 1.71 1.72
USD/CLP 485 460 435 437 438 440 450 448 452 455 460
USD/MXN 11.60 11.30 11.00 11.00 11.10 11.20 11.40 11.40 11.55 11.65 11.75
USD/COP 1770 1730 1750 1740 1760 1785 1805 1805 1815 1820 1830
USD/VEF 4.29 4.29 4.29 4.29 4.29 4.29 4.29 8.80 8.80 8.80 8.80
USD/PEN 2.75 2.70 2.68 2.66 2.65 2.66 2.68 2.69 2.70 2.71 2.72

Others Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13
USD Index 74.26 72.41 76.89 77.12 79.89 81.47 82.88 83.46 83.50 84.04 84.08
*End Quarter
Source: BNP Paribas

Foreign Exchange Strategy 12 May 2011

Market Mover, Non-Objective Research Section 79 www.GlobalMarkets.bnpparibas.com
Market Coverage
Market Economics
Paul Mortimer-Lee Global Head of Market Economics London 44 20 7595 8551 paul.mortimer-lee@uk.bnpparibas.com
Ken Wattret Chief Eurozone Market Economist London 44 20 7595 8657 kenneth.wattret@uk.bnpparibas.com
Luigi Speranza Head of Inflation & Fiscal Economics, London 44 20 7595 8322 luigi.speranza@uk.bnpparibas.com
Eurozone, Italy
Eoin O’Callaghan Inflation, Eurozone, Switzerland, Ireland London 44 20 7595 8226 eoin.ocallaghan@uk.bnpparibas.com
Gizem Kara Scandinavia London 44 20 7595 8783 gizem.kara@uk.bnpparibas.com
Dominique Barbet Eurozone, France Paris 33 1 4298 1567 dominique.barbet@bnpparibas.com
Julia Coronado Chief US Economist New York 1 212 841 2281 julia.l.coronado@americas.bnpparibas.com
Yelena Shulyatyeva US, Canada New York 1 212 841 2258 yelena.shulyatyeva@americas.bnpparibas.com
Bricklin Dwyer US, Canada New York 1 212 471-7996 bricklin.dwyer@americas.bnpparibas.com
Ryutaro Kono Chief Economist Japan Tokyo 81 3 6377 1601 ryutaro.kono@japan.bnpparibas.com
Hiroshi Shiraishi Japan Tokyo 81 3 6377 1602 hiroshi.shiraishi@japan.bnpparibas.com
Azusa Kato Japan Tokyo 81 3 6377 1603 azusa.kato@japan.bnpparibas.com
Makiko Fukuda Japan Tokyo 81 3 6377 1605 makiko.fukuda@japan.bnpparibas.com
Richard Iley Head of Asia Economics Hong Kong 852 2108 5104 richard.iley@asia.bnpparibas.com
Dominic Bryant Asia, Australia Hong Kong 852 2108 5105 dominic.bryant@asia.bnpparibas.com
Mole Hau Asia Hong Kong 852 2108 5620 mole.hau@asia.bnpparibas.com
Xingdong Chen Chief China Economist Beijing 86 10 6535 3327 xd.chen@asia.bnpparibas.com
Chan Kok Peng Chief Economist South East Asia Singapore 65 6210 1946 kokpeng.chan@asia.bnpparibas.com
Marcelo Carvalho Head of Latin American Economics São Paulo 55 11 3841 3418 marcelo.carvalho@br.bnpparibas.com
Italo Lombardi Latin America New York 1 212 841 6599 italo.lombardi@americas.bnpparibas.com
Nader Nazmi Latin America New York 1 212 471 8216 nader.nazmi@us.bnpparibas.com
Florencia Vazquez Latin American Economist Buenos Aires 54 11 4875 4363 florencia.vazquez@ar.bnpparibas.com
Michal Dybula Central & Eastern Europe Warsaw 48 22 697 2354 michal.dybula@pl.bnpparibas.com
Julia Tsepliaeva Russia & CIS Moscow 74 95 785 6022 julia.tsepliaeva@ru.bnpparibas.com
Interest Rate Strategy
Cyril Beuzit Global Head of Interest Rate Strategy London 44 20 7595 8639 cyril.beuzit@uk.bnpparibas.com
Patrick Jacq Europe Strategist Paris 33 1 4316 9718 patrick.jacq@bnpparibas.com
Hervé Cros Chief Inflation Strategist London 44 20 7595 8419 herve.cros@uk.bnpparibas.com
Shahid Ladha Inflation Strategist London 44 20 7 595 8573 shahid.ladha@uk.bnpparibas.com
Alessandro Tentori Chief Alpha Strategy Europe London 44 20 7595 8238 alessandro.tentori@uk.bnpparibas.com
Eric Oynoyan Europe Alpha Strategist London 44 20 7595 8613 eric.oynoyan@uk.bnpparibas.com
Matteo Regesta Europe Alpha Strategist London 44 20 7595 8607 matteo.regesta@uk.bnpparibas.com
Ioannis Sokos Europe Alpha Strategist London 44 20 7595 8671 ioannis.sokos@uk.bnpparibas.com
Camille de Courcel Europe Alpha Strategist London 44 20 7595 8295 camille.decourcel@uk.bnpparibas.com
Bülent Baygün Head of Interest Rate Strategy US New York 1 212 471 8043 bulent.baygun@americas.bnpparibas.com
Mary-Beth Fisher US Senior Strategist New York 1 212 841 2912 mary-beth.fisher@us.bnpparibas.com
Sergey Bondarchuk US Strategist New York 1 212 841 2026 sergey.bondarchuk@americas.bnpparibas.com
Suvrat Prakash US Strategist New York 1 917 472 4374 suvrat.prakash@americas.bnpparibas.com
Rohit Garg US Strategist New York 1212 841 3937 rohit.k.garg@americas.bnpparibas.com
Anish Lohokare MBS Strategist New York 1 212 841 2867 anish.lohokare@americas.bnpparibas.com
Olurotimi Ajibola MBS Strategist New York 1 212 8413831 olurotimi.ajibola@americas.bnpparibas.com
Koji Shimamoto Head of Interest Rate Strategy Japan Tokyo 81 3 6377 1700 koji.shimamoto@japan.bnpparibas.com
Tomohisa Fujiki Japan Strategist Tokyo 81 3 6377 1703 Tomohisa.fujiki@japan.bnpparibas.com
Masahiro Kikuchi Japan Strategist Tokyo 81 3 6377 1703 masahiro.kikuchi@japan.bnpparibas.com
Christian Séné Technical Analyst Paris 33 1 4316 9717 christian.séné@bnpparibas.com
FX Strategy
Ray Attrill FX Strategist New York 1 212 841 2492 raymond.attrill@us.bnpparibas.com
Mary Nicola FX Strategist New York 1 212 841 2492 mary.nicola@americas.bnpparibas.com
Kiran Kowshik FX Strategist London 44 20 7595 1495 kiran.kowshik@bnpparibas.com
James Hellawell Quantitative Strategist London 44 20 7595 8485 james.hellawell@uk.bnpparibas.com
Local Markets FX & Interest Rate Strategy
Drew Brick Head of FX & IR Strategy Asia Singapore 65 6210 3262 Drew.brick@asia.bnpparibas.com
Chin Loo Thio FX & IR Asia Strategist Singapore 65 6210 3263 chin.thio@asia.bnpparibas.com
Robert Ryan FX & IR Asia Strategist Singapore 65 6210 3314 robert.ryan@asia.bnpparibas.com
Jasmine Poh FX & IR Asia Strategist Singapore 65 6210 3418 jasmine.j.poh@asia.bnpparibas.com
Gao Qi FX & IR Asia Strategist Shanghai 86 21 2896 2876 gao.qi@asia.bnpparibas.com
Bartosz Pawlowski Head of FX & IR Strategy CEEMEA London 44 20 7595 8195 Bartosz.pawlowski@uk.bnpparibas.com
Elisabeth Gruié FX & IR CEEMEA Strategist London 44 20 7595 8492 elisabeth.gruie@uk.bnpparibas.com
Dina Ahmad FX & IR CEEMEA Strategist London 44 20 7 595 8620 dina.ahmad@uk.bnpparibas.com
Erkin Isik FX & IR CEEMEA Strategist Istanbul 90 (216) 635 29 87 erkin.isik@teb.com.tr
Raffaele Semonella EMEA Corporates Analyst London 44 20 7 595 8813 raffaele.semonella@uk.bnpparibas.com
Diego Donadio FX & IR Latin America Strategist São Paulo 55 11 3841 3421 diego.donadio@@br.bnpparibas.com

80
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Ann Aston, Market Economics, London. Tel: 44 20 7595 8503 Email: ann.aston@uk.bnpparibas.com,
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Roshan Kholil, FX Strategy, London. Tel: 44 20 7595 8486 Email: roshan.kholil@uk.bnpparibas.com,

2H

Martine Borde, Market Economics/Interest Rate Strategy, Paris. Tel: 33 1 4298 4144 Email martine.borde@bnpparibas.com
3H

Editors: Amanda Grantham-Hill, Interest Rate Strategy/Market Economics, London. Tel: 44 20 7595 4107 Email: amanda.grantham-hill@bnpparibas.com;
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